UCL FACULTY OF LAWS DISSERTATION COVERSHEET

Module Code: LAWSG_103_______

Course Name: CORPORATE FINANCE

Dissertation Title: THE INVESTMENT STRATEGIES IN NIGERIA: AN

APPRAISAL OF THE SHARE BUYBACK MECHANISM.

Candidate No. (This is NOT your student no): KJZK5

Word Count (includes all appendices & footnotes but not bibliography): 11,997

Name of your Tutor: DR ARAID REISBERG

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TABLE OF CONTENTS

Title Page…………………………………………………………………………….………. i

Table of Contents…………………………………………………………….……………… ii

INTRODUCTION……………………………………………………………………………1

CHAPTER ONE: Motivations for Share Buybacks…...……………………....…………. 4

CHAPTER TWO: NIGERIAN SHARE BUYBACK UNDER THE OLD

LEGISLATIVE REGIME

2.1 Share Buyback under the Common Law……………..………………..….………. 9

2.2 Share Buybacks under Nigerian Statue……..……………………..………………12

CHAPTER THREE: NIGERIAN SHARE BUYBACK UNDER THE NEW

LEGISLATIVE REGIME

3.1 Activities That Led To the Change in Legislation…………………………...…....16

3.2 Forms of Share Buybacks Permitted Under Sec Rules………………...................18

3.3 Authorisations Required Under the New Sec Rules………………….....………...21

3.4 Regulatory Restrictions Required Under the Rules………...……………..……...23

3.5 Financial Requirements Required Under the Sec Rules…………………...……..25

CHAPTER FOUR: LEGAL ISSUES ARISING FROM THE INTRODUCTION OF

SHARE BUYBACK IN NIGERIA

4.1 Share Buyback and Market Manipulation……………..……………………….....29

4.2 Share Buyback and Insider Trading…………………….………………...……….33

4.3 Share Buyback and Minority Protection………….……….……………..………..37

Conclusion………………………………………………………….……………...…………39

Bibliography……………………………………………………….…………...………...….40

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INTRODUCTION

Prior to the stock market collapse of March 2008, the Nigerian Capital Market was in

a Bull Run with investors reaping high returns in terms of dividends, bonus shares and capital

gains.1 This Bull Run was driven by the consolidation of the Banking and Insurance sector,

improved public awareness about the operations and opportunities in the capital market and

speculative activities and foreign investors’ interest in the market. The regulators did not

supervise the market properly as banks engaged in different sharp practices in the bid to tap

into the newfound goldmine. The banks engaged in series of public offers after the

consolidation and investors in the bid to invest sapped the capital market of its resources. The

different actions, which would be discussed below, led to the monumental collapse of the

stock market in March 2008 as share prices fell consistently and the market shrunk

occasioning losses to investors.

The government in response to the pressure mounted by Independent Association of

Shareholders to introduce share buybacks (SBB) to stabilize the market, after efforts to

reconstruct the shares failed, gave a directive for the reform of the Securities and Exchange

Commission Rules (SEC Rules).2 The 2008 reforms now allow companies to repurchase a

percentage of their shares. The amended SEC rules by adopting the English Companies Act

2006 (CA) departed from the position in the Companies and Allied Matters Act (CAMA) and

the old SEC rules. The two statutes adopted the old common law prohibition set out in Trevor

v Whitworth.3 The case established a rule that prohibits limited companies from repurchasing

their own shares. The rule seeks to protect creditors in the event of the company becoming

insolvent.

1 D. Ekineh, The Share Buyback Policy (Paper presented by SEC at the 12th Stockbrokers Annual Conference

and Investiture) p.2. available at www.stockmarketnigeria.com/forums/attachments/nigerian-stock-

exchange/675d1238119310-marketwatch-share-buyback.pdf accessed 10/07/09. 2 Rules made pursuant to the Investments and Securities Act 2007 (ISA). 3 (1887) 12 AC 409 (HL).

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SBB enables companies to “mop up” excess shares as a means of strengthening their

shares, improving the integrity and viability of the stock market and the economy. In In the

Matter of George Raymond Pty Ltd,4 Byrne J noted that a buyback is a contractual agreement

for the sale and purchase of shares in which the shareholders agree to transfer the shares to the

company and the company agrees to pay them. The company incurs a debt in the amount

agreed to be paid for the shares.5 Where the company repurchases the shares from its

shareholders, the shares can either be cancelled, kept in treasury or escrow until the directors

decide to reissue the shares. In addition, the SBB must not be prejudicial to either the

creditors or the company.

The amended SEC rules follow the trend in the UK and Australia. Both countries’

statutes on SBB have been gradually relaxed ‘over the years to extend the range of financing

options available in the corporate sector and increase flexibility.’6 The statutory powers to

repurchase shares in these jurisdictions are subject to restrictions intended to prevent abuse

that would prejudice creditors or discriminate against groups of shareholders.7 These

restrictions include authorisation, disclosure and other regulatory restrictions aimed to protect

creditors and investors in the event of winding up and market abuse.

SBB raises different issues from financial assistance, maintenance of capital and

market abuse. However, this research shall critically examine the SBB mechanism under the

amended SEC rules with a view to determining the efficacy or otherwise of the rules in

comparison to other jurisdictions. In addition, the legal issues ranging from market abuse to

minority protection will also be considered.

This dissertation consists of four chapters. The first chapter shall examine the

motivations for repurchasing shares, highlighting the effectiveness and the short falls of the

4 (2001) 19 ACLC 553 (HC). 5 R Tomasic, S Bottomely and R. McQueen, Corporations Law in Australia (Annandale, 2002) p.471. 6 Eilis Ferran, Principles of Corporate Finance (Oxford, 2008) p.204. 7 Ibid., p.204.

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arguments for repurchasing shares. The common law rule on buyback will be discussed in

Chapter Two. The chapter will focus on the rule in Trevor v Whitworth and the adoption of

the rule in Nigeria. The activities that led to the collapse of the Nigerian Capital Market and

the introduction of SBB will be considered in Chapter Three. The chapter will compare the

recent SEC amendments to the provisions in the CA. Chapter Four will show how officers can

use SBB to abuse the market and whether actions by shareholders for unfairly prejudicial

conduct will succeed.

In concluding this research, it will be indicative that the new rule, though a step in the

right direction is open to improvement to ensure it meets its objectives.

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CHAPTER ONE

MOTIVATIONS FOR SHARE BUYBACKS

Different companies may have different commercial reasons for repurchasing their

own shares. SBB can be used to return surplus cash to investors or increasing earnings per

share. Where the market is not as active as it should be, the company enhances its liquidity by

buying back shares. The reasons for repurchasing shares differ from company to company but

some are listed below.

Return surplus cash to shareholders.

Where a company is unable to effectively invest in ‘profitable investment projects’,8

the company can return surplus cash to shareholders by repurchasing shares. The company by

using SBB improves the performance ratio used by analyst to determine the corporate

performance of the company.

Where a company has surplus cash, a cash return may also be achieved by a court-

approved reduction of capital or takeover by a new holding company using a scheme of

arrangement. These two alternative investment strategies are quite complicated and make

them unattractive to directors unless the procedure is part of a larger transaction like a

‘demerger of companies’.9 If the company decides to issue a new class of special redeemable

share, capital may be difficult to achieve and return of cash will be spread over a number of

years.

Another less cumbersome option that a company has other than a SBB is to pay a

special dividend. This requires a consolidation and sub-division of the share capital and has

the capacity of leaving the company with shares dominated in fractions making it

unnecessarily complicated for shareholders to understand.10 An advantage a shareholder has

8 Ferran, Principles of Corporate Finance, n.6 above, p.204. 9 R. Skelton, Share Buyback Practice Manual (London, 2008) p.1.1. 10 Ibid, p.1.2.

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in buyback over a special dividend is that the shareholder has an option of either receiving

cash or not taking the SBB offer, thus enhancing the value of his existing investments.11

Increase in earning per share

Earning per share determines the corporate performance of a company and SBB

enhances this ratio. SBB enhances earnings where the benefit of reducing the shares

outweighs the negative impact on the company’s profits from loss in income generated from

the cash returned. A company can achieve this feat by financing the buyback with new debt.

This will occasion an increase in the company’s debt and reduce the assets of the companies.

Using a SBB to increase earnings per share may be prejudicial to creditors and the

shareholders because it reduces the available assets.

Some commentators have argued that earnings will not increase because the company

pays assets to finance the SBB and the size of the company will decline with a decrease in

outstanding shares.12 In 2006, the Royal Bank of Scotland repurchased shares worth £1

billion. After the repurchase, its share price increased by 2.7% on the day. However, the

increase was short-lived as taxpayers bailed out the company in 2008. This indicates that the

price increase may not be permanent especially if the company is in financial difficulties.

Stabilization of share price

Listed companies may use SBB as a tool to bolster or stabilize the price of their shares

especially when the shares suffer from liquidity. SBB will serve to enhance liquidity, by the

company being a purchaser and a seller, supporting a duly depressed share price.13 Where

SBB seeks to boost or stabilize the market, the activities may mislead investors about the

value of the shares, thus, creating a false market.14 Ferran believes the issue of manipulation is

11 Ibid, p.1.2. 12 J. Netter and M. Mitchell, ‘Stock – Repurchase Announcement and Insider Transactions after the October

1987 Stock Market Crash’ (1989) 18 Financial Management 84 p.85. 13 Richard Skelton, ‘Purchase and Holding of Own Shares’ (2003) Tolley’s Company Law Services Issue 72,

p6005/1. 14 General Pty Co ltd v Matheson’s Trustee (1888) 16 R 82 (Ct of Sess).

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not a problem in the UK because of the regulations against manipulation.15 This will pose a

problem in Nigeria because of poor supervision.

Informal reduction of capital.

Companies use SBB to reduce their capital without the need for court approval and

other conditions imposed by the different statutes. Hence, SBB is preferred as a cheaper and

more flexible alternative. ‘Historically, the potential for creditors to be prejudiced by an

informal reduction of capital was a key objection to allowing companies to repurchase their

shares.’16 In Trevor v Whitworth17 the House of Lord relied on maintenance of capital

principle in concluding that SBB was unlawful. In the UK, ‘objections to SBB that are rooted

in this concern have receded.’18 The use of SBB to reduce capital may pose a problem in

Nigeria where maintenance of capital is still a strong principle applicable to all companies.

This is because authorised capital is still viewed as the ultimate protection for creditors and a

reduction in a manner contrary to CAMA is illegal.

Buybacks as a defence to a takeover.

Over the years, SBB has been given as a defence to a takeover. This is done by

reducing the number of shares available to the hostile bidder or by the controllers of the

company buying out dissident shareholders at a favourable price.19 There have been two

hypotheses on this issue.20 The first is the shareholder interest hypothesis which suggests that

SBB done as a defence to a takeover is done in the interest of the shareholders. Managers

forced with a hostile takeover bid focus on short term investments like a SBB, thereby

encouraging institutional shareholders to hold on to their shares rather than selling as is

15 Eilis Ferran, Company Law and Corporate Finance (Oxford, 1999) p.435 16 Ferran, Corporate Finance, n.6 above, p.206 17 (1887) 12 AC 409 (HL) 18 Ferran, Corporate Finance, n.6 above, p206. 19 ibid, p.207. 20 IM Ramsay and AS Lamba, ‘Share Buy-backs: An Empirical Investigation’, available at SSRN

http://ssrn.com/abstract=227930. p.5.

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usually the case where there is a threat of a hostile takeover.21 This may not have an impact

on short-term investors but it allows the managers to make long-term investment decisions.22

The second is the management entrenchment hypothesis. It suggests that the managers

act solely on their own interest at the expense of the shareholders. The managers aim to

maintain their lucrative position by employing defensive tactics against the takeover, thus

making the company less appealing for the bidders.23 The company is made less lucrative by

increasing the leverage of the company and reducing the shares available to the bidder.24 This

may impede the efficient functioning of the market for corporate control and may not be in

the interest of the company especially if the company is going through financial difficulties.

To facilitate exit

Where a company’s articles of association restricts the transfer of shares or gives the

shareholders pre-emptive right to the company’s shares, SBB will be a useful tool for retiring

shareholders or the estate of deceased shareholders.25 Where the other shareholders are

unwilling or unable to pay for such shares, retiring shareholders are locked in the company

without any hope of exit and little prospect of receiving any dividends. In the worst possible

case, retiring shareholders may be forced to sell their shares to the members or directors at an

undervalued price.26 A retiring shareholder by selling to the company avoids any abuse that

may otherwise arise.

SBB can also be used to buy out a dissident shareholder. The court accepted this

argument in Re Dronfield Silkstone Coal Company.27 However, in Trevor v Whitworth, Lord

Macnaghten28 disagreed with this reasoning suggesting that it is healthy for the proper

functioning of any company to have shareholders that are critical of the actions of the

21 P Drucker, ‘Corporate Takeovers: What is to be done?’ (1986) 82 The Public Interest 3 at 13. 22 Ramsay, n.21 above, p.6. 23 Ibid, p.6. 24 Ibid, p.6. 25 Kinlan v Crimmin [2007] BCC 106 26 The Purchase by a Company of its Own Shares (Cmnd 7944, 1980) para 13. 27 (1881) 17 Ch D 76 (CA) 28 (1887) 12 AC 409 (HL), 435.

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company. This will reduce the likelihood of minority actions against the company. It is

noteworthy that a dissident shareholder may be detrimental to the company and in such

situations SBB may be the only plausible option to avoid excessive litigation.

Another problem that may arise where a SBB is used for the exit of shareholders is

that the directors may abuse this power by favouring certain shareholders, either because of

the special relationship that exists between them or in a bid to get rid of the shareholders.

Information signalling

Where the management of a company believes that the company’s shares are

undervalued, SBB can be used to signal shareholders and investors. Analysts believe the

signals may be ambiguous.29 On the one hand, it may be an indication that the management

has no better use for the company’s funds, thus, they enter into a SBB. On the other hand, it

could also indicate that the shares are undervalued and a SBB at a significant premium is a

good means of passing the information to the shareholders.30 Studies have shown that where

such an information signalling is made, there is usually a positive return on the shares and the

share prices do not return to their pre-SBB date level.31

In addition to the above reasons, SBB can be used to provide marketability in shares,

assisting in the operation of Employee Share Scheme or reconstructing the company’s balance

sheet.32

29 Ramsay, n.21 above, p.7. 30 Ibid, p.8. 31 LY Dana, ‘Common Stock Repurchases: An Analysis of Returns to Bondholders and Shareholders’ (1981) 9

Journal of Financial Economics 113. T Vermaelen, ‘Common Stock Repurchases and Market Signalling: An

Empirical Study’ (1981) 19 Journal of Financial and Quantitative Analysis 163 32 Skelton, Share Buyback Practice Manual, n.11 above, p.1.1.

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CHAPTER TWO

NIGERIAN SHARE BUYBACKS UNDER THE OLD LEGISLATIVE REGIME

In Nigeria CAMA restricts the acquisition by a company of its own shares.33

However, certain provisions in CAMA, like the CA allow Nigerian companies to repurchase

shares in very limited situations. The circumstances where a company is allowed to acquire its

own shares have been extended by the amendments made to SEC Rules in 2008. The new

rules seek to improve the financial management powers of the company’s managers to declare

SBB and decide on the type, timing and size of the SBB. This chapter will consider the old

common law position as adopted in Nigeria and its exceptions.

2.1 Share Buyback under the Common Law

The prohibition of SBB has been attributed to the decision in Trevor v Whitworth.34

Their Lordships were required to decide whether a company could repurchase its own shares

where the company’s articles provided that ‘any share may be purchased by the company

from any person willing to sell it and at such price…as the board thinks reasonable.’ Pursuant

to this provision, the company purchased shares from a shareholder that was financed by an

issue of promissory notes. The company went into insolvent liquidation after the transaction

and the shareholder brought an action for the balance payable on the shares. The court in

reversing the decision of the court of appeal disapproved the decision of the lower court in re

Dronfield Silkstone Coal Company,35 held that a company has no powers under the

Companies Act to repurchase shares and that any such repurchase was ultra vires and must

fail. The decision largely preceded on the technical basis that the purchase was ultra vires the

company as not being ‘in respect of or as incidental to any of the objects specified in the

33 CAMA, s 160. 34 (1887) 12 AC 409(HL). 35 (1881) 17 Ch D 76, CA.

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memorandum of association.’36 The court decided that the practice was ‘undesirable and

unlawful for reasons beyond the technical findings of ultra vires.’37

Their Lordships decision was based on a number of reasons. First, if the company

were to retain the shares, it would amount to an indirect method of reducing capital38 contrary

to the maintenance of capital doctrine and unlawful for not being in the prescribed manner of

reducing capital. Second, their Lordships found that if the company’s intention were to retain

the acquired shares to be resold at a later period, it would amount to trafficking of shares

which is expressly prohibited by the Companies Act.39

Third, the court agreed with the decision of the Master of Rolls in re Dronfield

Silkstone Coal Company40 that it was inconsistent with the nature of a company for a

company to become a member of itself. Lord Watson stated that ‘It cannot be registered as a

shareholder to the effect of becoming debtor to itself for calls, or of being placed on the list of

contributors in its own liquidation.’41 Fourth, the court held that the restrictions on SBB were

made to protect the interest of creditors. This is because the company’s paid up capital was

seen as the only protection the creditors had. Lord Watson stated

‘it is accepted as an unavoidable fact that the company’s paid-up capital may be

diminished or lost in the course of the company’s trading…they (creditors) are entitled to

assume that no part of the capital which has been paid in the coffers of the company has

been subsequently paid out, except for legitimate reasons.’42

Finally, their Lordships held that the SBB would undermine corporate governance. Their

Lordships were of the view that ‘it would be contrary to the climate of proper corporate

36 Ben Pettet, Company Law (Essex, 2005) p.286. 37 George O’Mahoney, Share Buybacks in Australia: Emerging issues (DPhil thesis, University of Oxford 2007)

p.20. 38 (1887) 12 AC 409, 417 (HL) 39 Ibid, 416 40 (1881) 17 Ch D 76, CA 41 (1887) 12 AC 409, 424 (HL) 42 Ibid 423, 424.

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management to give managers a means of buying out critics with the company’s capital.’43

Lord Macnaghten asked, ‘Is it possible to suggest anything more dangerous to the welfare of

companies and the security of their creditors than such a doctrine.’44 The most important basis

for the common law prohibition was the desire to protect both present and future creditors. A

SBB would lead to a diminution of the company’s issued and outstanding capital, which was

an unacceptable risk.45

‘This rationale has widely informed subsequent justifications of the SBB

prohibition.’46 The prohibition was however rejected in the US for being incompatible with

the country’s dynamic economy.47 The rule in Trevor v Whitworth was adopted in most

commonwealth jurisdictions. The Greene Committee endorsed the rule in the UK,48 but the

courts developed some exceptions.49 The Jenkins Committee50 acknowledged the usefulness

of the US practice concerning employee share scheme and unlocking investments in small

companies but thought that if such powers were to be given to English companies, stringent

safeguards would have to be introduced to protect creditors and shareholders.51 The

committee did not advocate for a total removal of the prohibition because it received no

evidence that British Companies needed such powers and because of the tax disadvantages

that would arise. By 1980, in the consultation document on The Purchase by a Company of its

Own Shares,52 Professor Gower recommended that companies should be allowed to issue

redeemable equity shares and repurchase their own shares. At the time of Gower’s review, the

43 O’Mahoney, n.38 above, p. 22. 44 (1887) 12 AC 409,(HL) 435. 45 O’Mahoney, n.38 above, p. 22. 46 Ibid, p. 22. 47 See Re Castle Braid Co. Ltd 145 Fed 224 (DC SDNY 1906), T Gardner, ‘Company Purchase of Own Shares

under the Companies Bill 1990 – A Sheep in Wolf’s Clothing’ (1992) 22 Victoria University Wellington Law

Review 159,159. 48 United Kingdom Company Law Amendment Committee: Report, (Cmd 2657, 1926). 49 Kirby v Wilkins (1929) 2 Ch 444 (CD). 50 United Kingdom Report of the Company Law Committee (Cmnd 1749, 1962) paras 167-9. 51 Ferran, Corporate Finance, n.6 above, p. 435. 52 Cmnd 7944 (1980).

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mood was against treasury shares. The issue was revisited in 199853 and the 1985 Companies

Act was amended in 2003 to introduce the limited power of companies to keep their shares in

treasury subject to the pre-emptive right of the shareholders.

The rule was applied in Australian cases.54 However, it was not effective as companies

were able to evade the prohibition.55 These companies relied on legal loopholes to engage in

semi-buybacks. One commentator described this scheme as ‘byzantine tactics to circumvent

the rule.’56 In August Investments Pty Ltd v Poseidon Ltd, P had shares in S and S sought to

make a hostile takeover against P. A who was also a shareholder of P objected on the ground

that it would amount to an indirect acquisition by P. The court held that it did not amount to

any form of acquisition.57 Relying on the loophole opened by the decision, large companies

were able to purchase their own shares through their associates and subsidiaries. Frustrations

that resulted from the interpretation of the Poseidon case58 and the general dissatisfaction with

the maintenance doctrine led to the introduction of SBB in Australia.

In Nigeria, the 1968 Companies Act codified the common law rule and it is retained in

the 2004 CAMA. The CAMA provision had no impact on the Nigerian corporate law, as

companies never tried to evade the prohibition. The lack of initiative may account for the

dearth of commentaries in this area of law until SEC amendments in 2008.

2.2 Share buybacks under Nigerian statutes

In Nigeria SBB is regulated by CAMA and the SEC Rules. While CAMA is

applicable to both public and private companies, the provisions in SEC are applicable to only

public companies. There are two regimes of SBB in Nigeria – the pre-2008 regime which

53 DTI, ‘Share Buybacks: A Consultation Document’ (1998). 54 Union Trustee Company of Australia v Greater Melbourne Realty Co (1932) 47 CLR 49 (High Court of

Australia). 55 Belmont Finance v William Furniture Ltd(No 2) (1980) 1 All ER 392 (CA); Burton v Palmer (1980) 2

NSWLR 878; Re Meyer Investment Property Ltd (1983) 68 FLR 15. 56 D Partlett and G Burton, ‘The Repurchase Albatross and Corporation Law Theory’ (1988) 62 Australian Law

Journal 139, p.140. 57 (1971) 2 SASR 71 SC, Dyson v Hutton Pty Ltd (1935) 41 ALR 419 SC. 58 R Lyle, Share Buy-back (Sydney, 1993) pp.8-14.

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relates to the CAMA provisions and the 2008 regime which is the new SEC rules. The pre-

2008 regimes will be discussed hereunder.

2.2.1 Share buybacks and CAMA.

Section 160 CAMA provides that a company may not purchase or acquire shares

issued by it. The section stems from the common law position that creditors should be

protected from incidents that are not in the company’s ordinary course of business.

The provision in CAMA is subject to the company’s articles of association and other

provisions in the Act. The effect is that where the articles permit a SBB, any repurchase made

by the company is valid. This is a departure from the rule in Trevor v Whitworth, that

permission in the articles does not affect the validity of the acquisition. The departure is

aimed to follow the general world trend.

Like the CA 2005, CAMA makes some exceptions59 to the common law provision.

The Act legalises a SBB that is made to settle a debt owed by the company. Where the

company has fractional shares which may affect the calculation of dividends, such shares are

to be bought back. Also exempted are shares purchased in fulfilment of the terms of non-

assignable agreements under which the company has an option or is obliged to purchase

shares owned by an officer or employee. The company was also permitted to repurchase

pursuant to a court order or to satisfy a dissenting shareholder.

CAMA provides additional restriction for the repurchase of shares. Where a company

is permitted to buyback its shares, such repurchase must be out of profits of the company that

would otherwise be available for dividends or the proceeds from fresh issue of shares made

for the purpose of the repurchase.60 The use of funds other than that available for payment as

dividends is a breach of the maintenance of capital doctrine. The company’s capital is seen as

a guarantee to creditors that their debt will be paid in full. The use of such capital for objects

59 CAMA, s 160(2)(a)-(e). 60 CAMA, s 161(a).

14

not authorised are prohibited. The funds available for dividends are not part of the company’s

capital and are used for different forms of reinvestments. Even with the exceptions provided

in CAMA, CAMA prohibited the company from purchasing more than 15% of its total

shares.61

Under CAMA, acquired shares can be cancelled or kept to be reissued at a later

period. Where the company cancels its shares, the company must alter its articles to reflect the

new share capital. The effect of this provision is that the company is indirectly permitted to

traffic its own share, a concept that was vehemently criticised in Trevor v Whitworth.

There is no provision in CAMA for the consequences for contravening the prohibition.

In the UK, where a company contravenes the general restrictions in section 658 CA, the

company is liable to a fine and every officer of the company who is in default is also liable to

imprisonment or a fine or both and the purported acquisition is void.62

2.2.2 Share buyback under the old SEC Rules.

Prior to the 2008 amendments, the old SEC Rules complemented the provisions in

CAMA. The rules were applicable to public companies and banks.63 The SEC rules like

CAMA lacked substance and had little impact on the Nigerian corporate law as against the

provisions in other jurisdictions. To ensure the liquidity and viability of the company, the

company was required to file an application accompanied by its last audited account to SEC

for approval.64 Rule 109(B) SEC Rules required any company wishing to repurchase its

shares to be authorised by its articles of association. Where the articles authorises a SBB, the

shares repurchased must not exceed 15% of the company’s issued capital.65 The identity of

61 CAMA, ss 161(c), 162. 62 Ferran, Corporate Finance, n.6 above, p.212. 63 SEC Rules 1999, Rule 109(B)(1). 64 Ibid, Rule 109(B)(2). 65 The new rules maintains this provision.

15

the company’s nominees and trustees must be disclosed66 and such persons were prohibited

from voting at meetings.67

Even though the rules had more procedural guidelines than CAMA, the provisions

were still laconic. Some of the lacuna in the rules has been addressed by the recent

amendments even though most of the old provisions are retained.

66 SEC Rules 1999, Rule 109(B)(4). 67 Ibid, Rule 109(B)(3)(iii).

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CHAPTER THREE

NIGERIAN SHARE BUYBACK UNDER THE NEW LEGISLATIVE REGIME

Before going into the legislative framework of the SEC amendments, it is prudent to

discuss first, the activities that led to the amendments. This chapter shall deal with the factors

that led to the changes in the SEC rules and shall analyse the provisions of the new rules.

3.1 Activities that led to the changes in legislation.

‘The Nigerian capital market was described as the fastest growing in the Sub-Saharan

Africa and lived up to this billing’68 until the Nigerian stock market crash of March 2008.

This was partly because of the recapitalization of Nigerian banks that was initiated in 2004

and the influx of foreign investors. The recapitalization exercise required Nigerian banks to

have a capital base of N25 billion. To raise this capital most banks engaged in public offers.

The banks that could not raise the required capital either merged with other banks or were

acquired. Once the shares were listed, investors witnessed a quick return as the unit price of

most shares doubled, boosting the stock market as a good means of investment, and leading to

an influx of investors.

Two years after the recapitalization exercise, most banks besieged the capital market,

competing amongst each other to raise funds through mega offers in a single trench.69

Through enticing marketing strategies, the banks succeeded in their various offers but that left

the market exhausted. The primary market experienced a boom while in the secondary market

investors dumped their shares opting to invest in the considerably cheaper primary market. A

total of N2.2 trillion was raised through various public offers dominated by banks and most of

the money came from the disposal of shares in the secondary market.

68 State of the Nigerian Capital Market and Share Buy-back. Available at

www.dominionng.com/LinkClick.aspx?fileticket=AXPODnAGvM%3D&tabid=67&mid=421 accessed on

29/07/09. 69 A. Olisaemeka, The Meltdown of the Nigerian Capital Market: Causes and Consequences. Available at

www.nairaland.com/nigeria/topic-241080.0.html accessed on 29/07/09.

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With the boom in the stock market, the banks saw the capital market as a prolific

investment. Thus, banks financed about 65 per cent of trading in the capital market through

short margin facilities granted to investors and stock broking firms.70 This margin facility

introduced by the banks was unsupervised and unregulated by the regulators – the Central

Bank, SEC or the Nigerian Stock Exchange. The market ceased to be an avenue for long-term

investments as speculators flooded the market. The speculative trading paid off until the crash

of March 2008.

The global financial crises saw foreign investors, who were already suffering huge

losses in their home countries, dispose their shares thus leading to excess shares available for

sale with few investors willing to buy. This proved disastrous as share price continued to

drop. Other than the international factors, the high cost of doing business in Nigeria led to the

closure of some plants like Dunlop Nigeria Plc. The effect left a lasting impact on the market

as the company’s share dropped from N6 to N0.6.71

The deficiencies in the regulations, especially the absence of market makers also

contributed to the collapse of the stock market. The inconsistencies and the lack of

transparency by SEC also contributed to the problem in the stock market. In 2008, SEC

publicly accused some of the listed companies of manipulating their shares and suspended

them. The announcement led to panic selling. SEC is yet to publish the result of the

investigation.72

The Nigerian government was first reluctant to interfere with the activities in the stock

market but with the continual drop in the price of shares, the fear of the crash in the market

and pressure mounted by the Independent Shareholders Association made the government to

act. According to a report,

70 ibid. 71 ibid. 72 ibid.

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‘...following anxiety about the looming possibility of a stock market crash in Nigeria

based on declining fortunes…, the federal government convened a meeting with capital

market stakeholders… to formulate policy measures that will restore stability in the stock

market’.73

Pursuant to the decisions made during the meeting, the office of the Attorney General was

directed to issue an exemption to the relevant sections of CAMA prohibiting SBB.74 Pursuant

to the directive, SEC Rules were amended allowing public companies to repurchase their

shares following the trend in other jurisdictions such as the UK, Australia and US. The

amendments aim to improve the bearish stock market by signalling investors that the prices of

the shares are undervalued and to increase the earnings per share of the companies.

3.2 Forms of share buybacks permitted under SEC Rules

There are different forms of SBB regulated in different jurisdictions. Some

jurisdictions regulate more forms than others, giving companies a diverse choice while

repurchasing their shares. The current Nigerian SBB regime recognises two different forms of

SBB; the on-market SBB and the tender offer.

A SBB is an on-market SBB if it results from an offer made by a listed corporation on

a prescribed financial market in the ordinary course of trading on that market.75 An on-market

SBB will not be in the ordinary course of trading if the company’s offer is not capable of

being accepted by any shareholder according to the exchange’s usual business rules.76 On-

market SBB is very common because it offers flexibility as well as regulatory scrutiny.77

Amongst the other forms of SBB, it is usually used for signalling. Rule 109B(3)(xiv) SEC

Rules provides that the SBB must be at the current market price. This rule is impracticable in

73 Stanbic IBTC Bank, ‘MARKET WATCH: Analysis of the Nigerian Stock Market Intervention’ (26 August

2008) available at www.stockmarketnigeria.com/.../477d1220010303-marketwatch-stanbic-ibtc-market-

watch_29-august-2008-edit.pdf. 74 Ekineh, n.1 above. 75 Corporations Act, Act No. 50 of 2001 as amended. s 257B(6). 76 Attorney General (Vic) v Walsh’s Holding Ltd (1973) VR 137, 144. 77 A. Idigbe, Nigeria: Legal Implications of Share buybacks (5) available at

www.allafrica.com/stories/200812170047.html

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the present market because most investors may be unwilling to sell at the present price. Using

Fin Bank as an example, before its initial public offer on January 3rd 2008, the bank was

trading at N13, and the offer price on the said date was N9.40 which dropped to N1.55 by

August 19th 2009 78 It is quite unlikely that any investor will be willing to sell at the current

price because the investor would make a loss of about N7.85 or more. Investors that used the

short loan margin will make more losses than others that did not borrow to purchase the

shares.

SEC prohibits the use of more than two stock broking firms or a stock broking firm

that is its subsidiary in buying the shares.79 This is aimed to avoid a false market effect. In the

UK, the Association of British Insurers allow companies to undertake this exercise if to do so

will result in an increase in the earnings and is in the best interest of the shareholders

generally.80 If this approach is applied in Nigeria, the aim of an on-market SBB would be to

increase earnings but at the going rate it will be suicidal for any investor to sell.

When a company engages in a tender offer, the company offers all shareholders the

opportunity to tender shares at a fixed price. This allows the company to repurchase a

substantial quantity of its own shares at a single trench, giving all the shareholders the same

opportunity to tender an offer.81 The tender is usually made at a premium as a compensation

for tendering the shares rather than holding on to the shares. 82 Rule 109B(xiv) SEC Rules

empowers the directors to determine the price which shall not be more than 5% above the

average market price over the last five trading days. This form of SBB will suffer the same as

the on-market SBB because at the present market it would be impossible to find sellers.

78Galleria Finance: Daily Stock Market Prices available at

http://www.nigeriagalleria.com/Galleria_Finance/Nigeria_Stock_Market_Reports/Daily_Stock_Prices_Wednesd

ay.html accessed 19/08/09. 79 SEC Rules, Rule 109B(3)(xxi). 80 Ferran, Corporate Finance, n.6 above, p.214 81 Ekineh, n.1 above, p.5 82 ibid, p.5

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The other forms of SBB will be discussed below. The company uses an equal access

SBB to make an offer to all shareholders to repurchase a uniform percentage of shares from

each shareholder.

In using a derivative-based SBB, the company purchases its shares by selling a put

option or warrant on its own shares, the issues provide the put buyer with a right to sell a

specified number of shares at a fixed price in the future. By buying a call option, the issuer

gains the right to buy a specified number of shares at a fixed price in the future.83

A company engages in an employee share scheme by buying shares held by or for the

benefit of current or former employees under an existing employee share acquisition plan

approved by the shareholders.84 This form of SBB enables the exit of former employees. This

has little effect on the capital maintenance protection available to creditors. Even though this

form of SBB is not expressly provided for in the SEC amendment, it is still applicable based

on the provisions in CAMA.

When a company engages in a selective SBB, the company repurchases shares from

one or more shareholders on a selective basis. The SBB does not result from an identical

proportional offer to all shareholders, nor does it involve an employee-share purchase, odd-lot

purchase or an on-market purchase.85 The number of shares purchased from one shareholder

need not bear any relationship to the number (if any) purchased from other shareholders.86

This form of SBB is often used as a defence mechanism by management to improve its

financial ratings by way of avoiding dilution of shares owing to an executive compensation,

or as a mechanism against a hostile takeover.87 The problem with this form of SBB is that

shareholders may be treated unequally.

83 ibid, p.5 84 Ramsay, n.21 above, p2. 85 ASIC, Policy Statement 110: Share Buybacks (Australia, 1998) p.6 86 Ibid, p.6 87 Idigbe, n.78 above

21

This form of SBB is similar to a fixed price tender offer. In Dutch auction SBB, the

company states the number of shares that it wishes to acquire. To achieve this, the company

sets a price range within which the shareholders may tender their shares rather than tendering

them at a predetermined fixed-price.88 The company receives the price required for the

minimum shares it requires and the shareholders receive the selected price for their shares.

This form of SBB sends signals to the market and results in long lasting increase in the value

of the shares of the company.89

The new SEC rules seem to have excluded these alternative forms of SBB. It also

seems to have excluded some types of SBB anticipated under CAMA. There is no reasonable

explanation for the new position. It may have been a regulatory oversight or because of the

stringent regulatory control that was introduced in the rules. In addition, the difference in the

markets may have contributed to the omission since Nigeria is a developing market and the

introduction of complex concepts may prove difficult to regulate. Because we are treading on

foreign ground, the rules on SBB are applicable to the two forms of SBB permitted unlike in

Australia and in the UK where specific rules regulate the different forms of SBB.

3.3 Authorisations required under the new SEC Rules

For a public company to repurchase its shares, the transactions must be authorised by

the shareholders and approved by SEC. It was previously required under the old rules for the

SBB to be authorised by the articles of association of the company.90 This has been removed

and the required authorisation for a SBB shall be by a special resolution of the company as

provided in CAMA.91 In the UK, the power of a company to repurchase its shares is subject to

restrictions provided in its articles.92 ‘That the 2006 Act provides that companies can

repurchase shares unless their articles provide otherwise is a reversal of the provision under

88 Ramsay, n.21 above, p4. 89 Idigbe, n.78 above. 90 SEC Rules 1999, Rule 109B(3)(i). 91 SEC Rules, Rule 109B(3)(iv). 92 CA, s.690.

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the previous company’s legislation, which was that specific constitutional authorisation via

the articles was required.’93 The new Companies Act provision is in line with the Second

Company Law Directive, which requires SBB to be authorised by the general meetings.94

In Nigeria, special resolution is required to authorise a SBB, and is applicable to both

the on-market SBB and the tender offer. The special resolution shall be as provided by

CAMA. Under Section 233(2) CAMA, a resolution is special if passed by not less than three-

fourths of the votes cast at a general meeting of which 21 days’ notice, specifying the

intention to propose the resolution as special is given. The notice of the meeting shall specify

the nature of the business at the meeting and the detail of the resolution.95 In addition to the

notice in CAMA, SEC in the bid to protect investors requires the company to publish in two

daily newspapers a notice of the general meeting to authorise the SBB and the evidence of

such publication filed with SEC.96

In the UK, there are different resolutions required for the different types of SBB

permitted. ‘Section 701 CA provides that the shareholder authorization required in respect of

an on-market purchase is a resolution, which implies an ordinary resolution.’97 In practice the

Association of British Insurers, require the resolution for an on-market SBB to be by special

authorisation.98 The authorisation for an on-market SBB may be a general authority not linked

to any particular SBB, but must specify the maximum number of shares to be authorised and

the maximum and minimum prices to be paid.99 Where the SBB is to be an off-market SBB,

special resolution is required.100 Before shares are repurchased, the company must authorise

the SBB or the SBB contract. The SBB contract must be made available for inspection by

members at the company’s registered office for not less than fifteen days ending with the day

93 Ferran, Corporate Finance, n.6 above, p.213. 94 Second Company Law Directive 77/91/EEC, [1977] OJ L26/1, Article 19. 95 CAMA, s 218. 96 SEC Rules, Rule 109B(3)(v). 97 Ferran, Corporate Finance, n.6 above, p.214. 98 IVIS Guidelines: Own Share Purchase. Available at http://www.ivis.co.uk/OwnSharePurchase.aspx 99 CA, s. 701(3). 100 Ibíd., s. 694.

23

of the resolution and at the meeting itself.101 Where creditors agree, they can waive the

provision.102

The authorisation requirement is mandatory103 in the UK where the provisions are

similar to the provisions of the SEC rules. Hence, the provision must be complied with even

in situations where the shareholders are willing to waive their rights. In such situations any

such acquisition is void.104 Even though the protection lies first with existing shareholders, the

protection extends to creditors and other investors.105

Once the members pass the special resolution authorising the SBB, the transaction

must be completed within twelve months. Notwithstanding the different types of shares

repurchased, each repurchase must be separated by a period of 365 days. This is different

from the trend in other jurisdictions. In the US the time, price, volume and number of brokers

are limited on a daily basis.106 In the UK, authorisation expires after eighteen months after the

passing of the resolution.107 ‘This time limit is consistent with the unamended Second

Company Law Directive Article 19.’108

3.4 Regulatory restrictions required under the Rules.

A company must not purchase its own shares if the purchase would be materially

prejudicial to the creditors. Hence, an illiquid company is prohibited from carrying out a

SBB.109 SEC introduced two investor protection rules. The first protection against an illiquid

company is the requirement that the company’s auditors are to file a letter on the status of the

101 Ibíd., s. 696(2)(b). 102 Kinlan v Crimmin [2007] BCC (CD) 106, citing BDG Roof-Bond Ltd v Douglas [2000] 1BCLC 401(CD). 103 Re RW Peak (Kings Lynn) Ltd [1998] 1 BCLC 193 (CD). 104 Wright v Atlas Wright (Europe) Ltd [1999] 2 BCLC 301 CA, 310-15 per Potter LJ in Ferran, Corporate

Finance, n.6 p.217; Note CA, s 696(5). 105 Ibid, 204-5. 106 Idigbe, n.78 above. 107 CA, s 694(5). 108 Ferran, Corporate Finance, n.6 above, p.216, n55. 109 SEC Rules., Rule 109B(3)(xiii).

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company with SEC. The audited accounts showing the status of the company shall not be

more than nine months prior to the buyback.110

The second protection accorded to creditors is required from the directors to ensure

that the company is liquid or will not go into liquidation after the SBB. The directors are

required to make a declaration of solvency that they believe that the company will remain

solvent in the foreseeable future.111 This is to ensure that directors are accountable and adhere

to their duty to inform the shareholders of any serious loss in capital.112 There is no time limit

for the declaration but in Australia, under the 1989 Corporations Act, companies were

required to make a solvency statement that the company would remain solvent twelve months

after the SBB. The statement must not be more than two months to the commencement of the

acquisition.

If an Australian company became insolvent during the period of twelve months after

the SBB, the directors who signed the solvency statement will be liable to indemnify the

company for the funds it paid out to the shareholders to repurchase their shares.113 SEC has no

provision on consequences for making a false declaration but liability can be inferred from the

duties of a director and CAMA. Since directors are fiduciaries, a breach of Rule 109B(xii)

SEC Rules will amount to a breach of a director’s fiduciary duty to act in utmost good

faith.114 Under CAMA a director, who makes a declaration without reasonable ground for the

opinion that the company will be able to pay its debts in full within the period specified shall

be guilty of an offence. The director shall be liable on conviction to a fine of N1500 or to

imprisonment for a term of three months, or both within a period of five weeks after making

the declaration. 115 There is always a presumption that the directors’ declaration is valid. If

110 Ibid, Rule 109B(3)(xiii). 111 Ibid, Rule 109B(3)(xii). 112 CAMA, s 112. 113 Ramsay, n.21 above, p. 21. 114 CAMA, s 279, Re City Equitable Fire Insurance Co (1916) 32 T.L.R. 253 (CD). 115 CAMA, s 462(3).

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the company’s debts are not paid or provided for in full within the period specified for in the

declaration, the presumption ends. Even though CAMA tries to fix the lacuna, the

punishments neither deter directors nor indemnify investors for losses suffered.

3.5 Financial Requirements required under the SEC rules.

The SBB must not result in the company’s insolvency. Hence, the source of financing

the buyback must be disclosed.116 Since the SBB however has an implication on the

shareholders, the shares shall be repurchased out of the share premium account or any other

accumulated profit of the company that would otherwise be available for dividends.117 The

reduction in the company’s cash or other assets represented by the purchase price will be

matched by a reduction in the distributable reserves.118 Another source of funds in the UK is a

fresh issue of shares to finance the repurchased shares provided the issue was made for the

repurchase.119 The company uses its distributable profits to pay for any premium payable on

the purchase. Where shares were issued at a premium, the company may pay a premium on

the redemption out of the proceeds of the fresh issue of shares. The company can pay ‘up to

an amount equal to the lesser of the aggregate of the premiums received by the company on

the issue of the shares repurchased and the current amount of the share’s premium account

(including any premium in respect of the new shares).’120

To ensure the financial soundness of the company after the SBB, Rule 109B(3)(xx)

prohibits the company’s capital to fall below the legally prescribed minimum for the line of

the particular business. The rule is more pertinent in specific sectors like the banking sectors,

pension fund administrators, insurance companies and unit trust managers required to keep a

certain minimum capital under their various statutes. This stems from the maintenance of

capital doctrine, that the company’s capital protects creditors in event of the company’s

116 SEC Rules, Rule 109B(3)(xix). 117 Ibid, Rule 109B (3) (vi). 118 Ferran, Corporate Finance, n.6 above, p.218. 119 Ibid, p.218. 120 CA, s 692(2) (a) (i). Ferran, Corporate Finance, n.6 above, p.218.

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insolvency. This doctrine has been criticised in the UK. Commentators believe that the

doctrine is an outdated concept and does not offer real protection to creditors. 121 In the UK,

the minimum share capital requirement for public companies is not a capital adequacy rule

but simply a requirement that a minimum amount of capital must be issued at formation.122

The concept is seen as outdated because creditors can have contracts123 with the company to

protect their interests or rely on the claw back provisions.124 These remedies are not available

to creditors of Nigerian companies, hence, the retention of the maintenance of capital

doctrine.

The company is required to buy the shares directly from the seller for its own

benefit.125 Repurchased shares must be cancelled in accordance with the procedures set out in

CAMA.126 Section 106 CAMA requires the reduction of a company’s capital to be authorised

by the articles and confirmed by the courts after the shareholders have made a special

resolution.127 The court order confirming the reduction and the minutes of the meeting is to be

at the Corporate Affairs Commission.128 The provision in CAMA applies to all companies

registered by the commission and does not improve the rules on SBB by ensuring that

companies repurchasing their shares do not prejudice creditors.

The Nigerian approach differs from the UK approach. In the UK, the laws relating to

SBB are specific to the mechanism. Thus, where shares are cancelled as a result of a SBB

from distributable reserves, an amount equivalent to the nominal value of those shares must

be credited to a capital redemption reserve, which is to be treated as if it were share capital

121 J Armour, ‘Legal Capital: An Outdated Concept?’ (2006) 7 EBOLR; Alexander Daehnert, ‘The minimum

capital requirement - an anachronism under conservation’ (2009) 30 Company Lawyer 34. 122 CA ss 761-767, Araid Reisberg, ‘Maintenance of Capital: power point lecture slides’

http://moodle.ucl.ac.uk/mod/resource/view.php?inpopup=true&id=107195. 123 WW Bratton, ‘Bond Covenants and Creditor Protection’ (2006) 7 EBOLR 39-87. 124 R Calnan, Taking Security: Law and Practice (Bristol, 2006) chapter 9; Goode: Principles of Corporate

insolvency Law (London, 2005) chapter 11. 125 SEC Rules, Rule 109B(3)(ix). 126 Ibid, Rule 109B(3)(x). 127 CAMA, s 106(1). 128 Ibid, s 109.

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with the one exception that it may be used to pay up fully paid bonus shares.129 This is to

prevent SBB being used to reduce the share capital. When shares are bought from the

proceeds of a fresh issue of shares made specifically for that issue, the capital redemption

reserve will be credited with the amount by which the aggregate amount of the proceeds is

less than the aggregate nominal value of the shares purchased.130 In effect, the new capital

raised from the issue of shares takes the place of the repurchase sum. Creditors are not

prejudiced because the fresh issue was made for the purpose of the SBB and not as an

injection of new equity finance.131 The UK provisions are specific on what happens to the

shares and the measures of using SBB as means of capital reduction. The Nigerian section

under review is on the general reduction of capital and may not be an adequate provision in

the present financial climate.

Rule 109B(3)(viii) SEC Rules provides that the Debt-Equity Ratio after a SBB

programme shall not exceed 2:1, the equity for this purpose being the shareholders fund. The

ratio is a measure of the company’s financial leverage. High debt/equity ratio generally

indicates that a company has been aggressive in its debt financing, thereby using less equity

capital to finance its assets. Investing in a company with a high debt/equity ratio is riskier

especially in times of rising interest rates, due to additional interests that have been paid for

the debt capital. 132 The company may be subject to volatile earnings because of additional

interest expense. Such aggressive debt financing may result in higher earnings on returns.

SEC by the restriction tries to protect the company from too much exposure to the volatile

conditions of the market by fixing a maximum of 50% loan to the value ratio.133 It seems that

129 CA, s 733. 130 Ibid, s 733(3). 131 Ferran, Corporate Finance, n.6 above, p. 9. 132 Idigbe, n.78 above. 133 Ibid.

28

the 2:1 imposition is arbitrary. Gearing ratio varies from industry to industry, so to put a one-

fits-all solution may not be appropriate.134

134 Ibid.

29

CHAPTER FOUR

LEGAL ISSUES ARISING FROM THE INTRODUCTION OF SHARE BUYBACK IN

NIGERIA

The amendments made to the SEC rules in 2008 are quite laudable but certain market

forces may affect the policy making it difficult and expensive to carry out. A question arises

whether the new rules can co-exist with the current restrictions in CAMA. The directive given

to the Attorney General of the Federation to waive section 160 CAMA, to make allowance for

the application of the SEC amendments, is unconstitutional.135 The power to make laws is

within the domain of the National Assembly and it cannot be delegated.136 The discussion on

the interference by the Attorney General is beyond the scope of this work. The SEC rules

cannot be fully enforceable and applicable, until the prohibition in CAMA is amended.137

Other than the constitutionality of the directive given to the Attorney General, other issues

may arise ranging from actions against unfair conducts and market abuse whether in the form

of market manipulation or insider trading.

4.1 Share buyback and Market Manipulation

Market Manipulation ‘is a course of conduct intended to rig or distort the price of

securities with the view to deceiving other users of the market in order to make a profit or

avoid a loss.’138 It is not market manipulation to buy shares with a view to making a profit

even though the purchase of a large line of shares can result in an increase in the value of the

securities so that profit can be realised.139 The essence of all trade is the profit made between

the purchase and sale price and this makes it difficult to distinguish between an ordinary

135 A.G. Abia State V A.G. Federation (2002) 95 LRCN 407(Nigerian Supreme Court). 136 1999 Constitution, s.1 (3), s.4. 137 A. Jemide, “Come on SEC, Think outside the box” available at http://www.detail-solicitors.com/sec.pdf

accessed on 12/07/09. 138 Philip Wood, Law and Practice of International Finance: University Edition (London, 2008) p.391. 139 Philip Wood, Regulation of International Finance (London, 2007) p. 534.

30

transaction not intended to influence the price and a transaction that intends to manipulate the

price by deliberately changing it up and down.140

Equity price manipulation is an offence in Nigeria. Section 105 ISA expressly

prohibits false trading and market rigging transactions141 whether in the form of fictitious

transactions or devices to maintain, inflate, depress or cause fluctuations in the market price

of any securities. SBB would violate Section 105 ISA if it were conducted with the intention

of boosting or stabilising the market price. A similar provision exists in US.142 However, US

SEC rules provide companies with a safe harbour if the companies do not repurchase shares at

the start or during the last half hour of trading or conduct all repurchases through one

brokerage firm.143

The prohibition in Section 105 also applies to the dissemination as well as authorizing

the dissemination of materially false or misleading information likely to induce the sale or

purchase of securities by others or likely to affect the price of securities.144 Studies have

shown that signalling is one of the key motivations for a SBB and that the announcement

usually boosts the price of the shares whether abnormally or otherwise.145 A SBB

announcement may be an incentive for managers aiming for the highest possible price for

their shares. To do this, managers can use the signal from the announcement for sinister

purposes by boosting the price of the shares and selling immediately afterwards. Managers

aware of the price spike of SBB announcements may announce a SBB they do not intend to

carry out.146 According to one commentator:

140 Ibid, p.534. 141 Paul Usoro and Co, “Equity Price Manipulations in Nigeria: Legal Issues.” (2008) PUCJ p.2. 142 US SEC Act 1934, s 9(a)(2). 143 US SEC rule 10b-18. 144 Usoro, n. 135 above, p.2. 145 T. Vermaelen, ‘Repurchase Tender Offers, Signalling, and Managerial Incentives’ (1984) 19 Journal of

Financial and Quantitative Analysis 163; Netter and Mitchell, n.13 above, p.85. Vermaelen, n.31 above. 146 M Simkovic ‘The Effect of Enhanced Disclosure on Open Market Stock Repurchases’ available at

http://blogs.law.harvard.edu/corpgov/files/2007/05/20070516%20Open%20Market%20Stock%20Repurchases.p

df accessed on 15/07/09.

31

‘Managers can exploit the market’s predictable reaction to repurchase announcement by

announcing…buyback programs they have no intention of conducting, and then unloading

their shares at the higher post-announcement price.’147

The practice is referred to as ‘false signalling’ and is usually used by managers of

undervalued company to repurchase at a low price.148 When managers give a false signal, they

hope that investors view the SBB as an indication that the market is undervalued. A SBB

announcement is not binding on the company,149 thus the company is not liable in damages if

it fails to purchase any of its shares or if it does not purchase the number of shares

announced.150 A study estimates that within three years of a SBB, 43% purchased fewer

shares than announced, while 10% bought less than 5% of the announced target.151 Amongst

the SBB announced, only 27% repurchased shares within the announcement.152

False signalling is a breach of section 105 ISA prohibition on companies

disseminating misleading information in other to boost the price of their shares. This section

is similar to section 1041A Corporations Act 2001, which provides that a person should not

carry out transactions likely to have the effect of creating an artificial trading price for a

financial product or security.153 Substantive dissemination of misleading information will

make managers liable. A problem usually arises where the plaintiff is to prove that the

managers did not intend to carry out the SBB. According to O’Mahoney:

147 J Fried ‘Informed Trading and False Signalling with Open Market Repurchases’ (2005) California Law

Review, Vol. 93, pp. 1323-1386. 148 O’Mahoney, n.33 above, p.158. 149 D. Ikenberry and T. Vermaelen, ‘The Option to Repurchase’ (1996) 25 Financial Management 9, p.10. 150 Barclays Bank v British & Commonwealth Holdings [1995] BCC 19 CA, Michael Wyatt, Company

Acquisition of Own Shares (Bristol, 2004) p.51. 151 C Stephens and M Weisbach ‘Actual Share Reacquisitions in Open-Market Repurchase Programs.’ (1998)

Journal of Finance 53 pp.313-333. 152 U Bhattacharya and A Dittmar ‘Costless Versus Costly Signalling: Theory and Evidence.’ Available at

http://ssrn.com/abstract=250049 153 O’Mahoney, n.33 above, p.159.

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‘Management may readily cite changing market conditions, the emergence of new business

opportunities or a material shift in the company’s share price, as a reason for not

proceeding with a repurchase transaction.’154

The failure to carry out an announced SBB may be because of legitimate changing conditions

between the time of the announcement and the execution. This can be attributed to the fact

that shares are not repurchased immediately after the announcement to purchase is made. In

the period between the announcement of the SBB and the repurchase, different unanticipated

but positive changes may be felt in the market leading to a change in the original intendment

to repurchase shares. Such positive changes may make the managers reverse their decisions to

engage in the SBB. An example of such changes is equilibrium returns to the stock market.155

The system of disclosure enshrined in the SEC rules maybe a tool to prevent

manipulation. SEC requires a company to make a public announcement in at least two

national daily newspapers, at least five days to the commencement and conclusion of the

buyback, disclosing relevant information such as the proposed size, nature, duration and

potential impact on the company’s financial position. In addition, the financial adviser of the

company shall file a report not later than five working days after each month indicating the

number of shares repurchased, the total amount paid, and the number of shares cancelled. The

disclosure requirement will check manipulation because investors will lose confidence in

companies that do not repurchase shares after a SBB announcement. Hence, there is the need

to prevent companies from giving such signals. A way of preventing such signal is to mandate

companies that have approval from SEC to repurchase the shares irrespective of the change in

the market. In addition, SEC may mandate companies that already have the commission’s

approval to repurchase to do so irrespective of the change in the market.

154 Ibid, p.159. 155 Ibid, p.160.

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4.2 Share buyback and Insider Trading

According to Phillip Wood,

‘Insider dealing (sometimes called insider trading) occurs where a privileged insider, such

as an officer or professional adviser, who has unpublished material price-sensitive

information about securities gained by virtue of his relationship with the company, exploits

that information to make a profit or avoid a loss by dealing in the securities, the price of

which would have been materially altered if the information had been disclosed.’156

From the definition given above the main aim of insider trading like market manipulation is to

buy low and sell high. The two concepts can be quite confusing but while in market

manipulation, the manipulator aims to rig the market in order to deceive other investors in

investing and in turn, he makes a profit or avoids a loss. An insider utilizes157 material,

undisclosed, price-sensitive information to make a profit or avoid a loss. Therefore, to prove

the offence of insider trading, a party is required to prove that the information was material

and yet undisclosed at the time.

The price-effect from a SBB announcement may increase the prospect of insiders

profiting at the expense of other shareholders and investors because of the significant short-

term gains in the repurchasing company’s share price. This is associated more with off-market

SBB than with the on-market SBB. This can be attributed to the fact that the company as the

price maker purchases at a premium as against an on-market SBB where the price is

determined by market forces. Studies have also shown that off-market SBB are usually larger

and elicit more sizeable share price gains.158

The abnormal returns associated with SBB announcement is an incentive for insiders

to use the information in their personal trading, whether investors see the announcement as a

156 Wood, Regulation of International Finance, n.139 above, p.552. 157 ISA, s 315. 158 S. Ekanayake, ‘Information Signalling of Share Buy-Back Announcement – Recent Australian Evidence’

(Working Paper, Deakin University 2004) p.18-20 in O’Mahoney p.154.

34

signal that the shares are undervalued or not. Insiders armed with the knowledge of the

possible effect of the announcement, purchase shares before the company announces the

buyback. After the announcement and the abnormal returns associated with the repurchase

price-effect is secured, the insiders sell the purchased shares either in the weeks or months

following the announcement.159 In Nigeria to prevent this sort of dealings, directors are

required to file a detail of their shareholding while the company is required to file quarterly

returns of the acquisition and disposals.160 This is to restrict insider dealings and ensure that

directors maintain their fiduciary duties. Time will tell whether this requirement will be

effective.

Insiders can take advantage of price-sensitive information without buying or selling

their own shares. While in personal insider trading, the insider relies in price-effect of the

SBB announcement, in ‘indirect’ insider trading, the insider relies on the distributional effects

of the buyback transactions. The directors by conducting a SBB and not selling their shares

increase the proportional value of their shares. Where the repurchase price is below the value

of the company’s shares, managers are able to transfer value to themselves (and other non-

selling shareholders) by effectively purchasing shares at a bargain.161 The company transfers

value in the shares pro rata. Hence, the more shares a person has the more value he gets. The

non-selling manager has a greater incentive when the shares are under-priced. Some US cases

demonstrate the danger of indirect insider dealings. In Walker v Action Industries Inc,162

management caused the company to conduct a SBB while aware of a forecast predicting the

increase in orders and sales that caused the share of the company to rise. By not selling their

shares, the managers were able to increase their proportionate ownership.

159 O’Mahoney, n.33 above, p.156. 160 SEC Rules, Rule 109B(iv). 161 O’Mahoney, n.33 above, pp.169-170. 162 906 F Supp 1145(E D Mich 1995); Lessner v Casey 681 F Supp (E D Mich 1988).

35

Insider trading like market manipulation is very difficult to detect. Buyback-related

insider trading will prove a bigger challenge to Nigerian regulators because of its elusive

nature. In Australia, buyback-related insider trading has not been subjected to scrutiny unlike

takeover-related insider trading. This is besides the fact that commentators believe that it

would most likely accompany a repurchase, and because of its form, would most likely go

undetected.

Given that a SBB announcement would lead to insider dealing, the question emerges;

what makes a SBB announcement so elusive that it usually goes undetected? The answer lies

in the limited prospect of liability.163 There are two reasons that make liability less likely for

insider dealings around SBB. The reasons are detection of the insider activity and

prosecution. Insider dealings around SBB are less likely to attract the regulators because the

regulators usually focus on dealing around announcement that have a more pronounced share

price impact like announcements concerning takeovers, earning forecasts, dividends, capital

expenditure and asset sales. In R v Hannes,164 the defendant was aware of an impending,

undisclosed takeover bid for TNT purchased the company’s shares and made a profit of Aus$

2million.165 In this case and most other cases investigated by the Australian Securities and

Investment Commission (ASIC), the price increase attracts the commission’s attention. Even

though profitability is not a prerequisite for an insider dealing offence in Australia, the

position taken by the commission is borne out of practical consideration about allocating

limited resources.166 The effect is that the buyback-related insider trading carries a lower risk

of detection.

163 O’Mahoney, n.33 above, p.161. 164 [2000] NSWCCA 503(Criminal Appeal). 165 R Januarita, ‘Australia and Indonesia: a comparative analysis of insider trading regulation’ (2003) Company

Layer p.313. R v Rivkin (2004) 59 NSWLR 284 (SC); R v Firns [2001] N.S.W.C.C.A. 191(HC). 166 T Sykes, ‘Share Buybacks are on the Nose’ Australian Financial Review (Sydney 11 June 2004) p.17 in

O’Mahoney, n.33 above, p.162.

36

The second reason concerns the difficulties that are likely to arise in prosecuting an

insider. The materiality requirement in section 315 ISA makes it difficult to prosecute

investors.167 The section prohibits dealings or tipping others to deal in securities while in

possession of price sensitive information which if made known to the public is likely to affect

the price of the securities materially. What amounts to a material impact was not defined in

both the Nigerian and the Australian Acts. Trading prior to a takeover168 or a merger169 will

have a material impact on the shares. The question arises whether information about an

impending undisclosed SBB would have the same effect.170 This has not been tested in

Australia but O’Mahoney believes ‘a court is likely to have regard to the circumstances of the

case regarding both the proposed SBB and the position of the repurchasing company.’171 It is

quite unlikely that the announcement would have a material effect irrespective of the

empirical evidence on the abnormal earnings after a SBB announcement. This is because the

price impact on the shares is not high enough for the regulator to notice the trading.

In the US, Rule 10b-5 of the Securities and Exchange Act 1934 also provides for

materiality. The courts in the US adopt a high threshold for materiality. Not every inside

information will entail a prosecution of the insider. The information must be a ‘bombshell

event’172 like a takeover or capital expenditure. In Basic Inc v Levinson,173 the court held that

the information is not material even if the insiders earn profit while trading. It is quite

unlikely that the US courts would consider a SBB announcement as material where an insider

purchases before the SBB. If this degree of proof were adopted in Nigeria with its developing

market where investors are hardly protected, it would increase the hardship suffered by

investors. Such an approach by the courts will dissuade investors who may be unwilling to

167 Corporations Act, s 1042A. 168 R v Hannes [2000] NSWCCA 503(Criminal Appeal). 169 Toledo Trust v Nye 588 F.2d 202 (6th Cir 1978). 170 O’Mahoney, n.33 above, p.163. 171 Ibid. 172 D Carlton and D Fischel, ‘The Regulation of Insider Trading’ (1983) 35 Stanford Law Review 857 p.886. 173 485 US 224, 234 (SC).

37

invest in the stock market because of the burden of proof that has to be met before a director

is found liable for buyback-related insider dealing.

From the above analysis, it seems almost impossible to prosecute an officer from

buyback-related trading. Hence, a new rule prohibiting repurchases preceding preliminary

announcements of annual results or the publication of interim reports may be adopted and

managers should be prohibited from buying before or selling after announcements. SEC can

in turn monitor the repurchases through the shareholding details and the quarterly returns.

4.3 Share buyback and Minority Protection

Where a shareholder objects to a buyback transaction, it is open to such a shareholder

to seek relief under section 311 CAMA, on the ground that the action amounts to an unfairly

prejudicial conduct.174 It may be difficult for a shareholder to prove that a SBB is unfairly

prejudicial to him. In Rutherford, Petitioner,175 the company sought to repurchase 33% of its

shares at a premium, aimed to satisfy the view of most shareholders that the shareholding

should be widely spread and that there should not be any dominate block of shares. The

petitioner sought an injunction against the company because the company was purchasing its

shares at a premium, which it lacked the funds to purchase and that the elimination of block

shares would discourage investment trust willing to pay premium price for controlling shares.

The court refusing the request for an injunction held that the shares selling below the

premium price were small blocks of shares and that the bulk of the shares were worth

considerably more. The court held that the petitioner was unable to prove that the company

was unable to finance the purchase. Although the petitioner alleged that the repurchased

shares discouraged the investment trust from purchasing the controlling shares, the court held

that since the repurchase was what the majority wanted, the petitioner was unable to prove

174 Ferran, Company Law and Corporate Finance, n.16 above, p.453. 175 [1994] BCC 876 (CS).

38

how the decreased chance of securing a bidder could be described as unfair.176 It may be

difficult for a shareholder to prove that the SBB was unfairly prejudicial.

176 Ferran, Company Law and Corporate Finance, n.16 above, p.454.

39

Conclusion

The introduction of SBB is a step in the right direction as Nigeria seeks to follow the

trend in other jurisdictions. However, Nigerian investors view dividends as a source of

income and before investors can opt for SBB over dividends, the legislation has to be clear

and straightforward. Because the government was under pressure to stabilize the ailing

market, some provisions that would have ensured the smooth operation of the mechanism

were omitted.

To use SBB to stabilize the ailing market, some reforms need to be made. First,

CAMA should be amended to incorporate the provisions in the rules by removing the SBB

prohibition. This will eliminate any conflict that may arise between the two statutes. The

provision on declaration of insolvency should be changed so that directors who declare

wrongly will indemnify investors for any loss suffered. Second, companies should be

prohibited from purchasing shares where to do so would result in the existence of only

redeemable shareholders. This reform will ensure that the company will not use SBB to end

its existence.

Third, ISA needs to define the materiality requirement incorporating SBB as having a

material impact. This will ensure that the need for a material impact will not out-weigh the

need to protect investors. Fourth, exceptions should be made to s.105 ISA to enable

companies repurchasing shares to boost or stabilize their shares to avoid falling foul of the

section.

If the previously mentioned issues and suggestions are adopted, it will ensure the

smooth operation of SBB in Nigeria and may even introduce a safe means of investment.

40

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46

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R v Hannes [2000] NSWCCA 503.

R v Rivkin (2004) 59 NSWLR 284

Re Meyer Investment Property Ltd (1983) 68 FLR 15

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CLR 49.

ENGLAND

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Kinlan v Crimmin [2007] BCC 106

Kirby v Wilkins (1929) 2 Ch 444.

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Trevor v Whitworth (1887) 12 Appeal Case 409 (HL)

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SCOTLAND

Rutherford, Petitioner, [1994] BCC 876.

UNITED STATES

Basic Inc v Levinson 485 US 224, 234

Lessner v Casey 681 F Supp (E D Mich 1988).

47

Re Castle Braid Co. Ltd 145 Fed 224 (DC SDNY 1906),

Toledo Trust v Nye 588 F.2d 202 (6th Cir 1978).

Walker v Action Industries 906 F Supp 1145(E D Mich 1995)

TABLE OF STATUTES

NIGERIA

Companies and Allied Matters Act 2004

Nigerian Companies Act 1968

Investments and Securities Act 1999

Securities and Exchange Commission Rules as amended.

FOREIGN STATUTES

AUSTRALIAN Corporations Act 2001(Cth)

AUSTRALIAN Corporations Act 1989

English Companies Act 2006

Second Council Directive 77/91/EEC of 13 December 1976

United States Securities and Exchange Act 1934

TABLE OF ABBREVIATIONS

SBB- Share Buybacks

CAMA – Companies and Allied Matters Act

SEC – Securities and Exchange Commission

ISA – Investments and Securities Act

CA – Companies Act

App Cas – Appeal Cases

ACLC – Australian Company Law Cases

Ch D – Chancery Division

CA – Court of Appeal

48

SC – Supreme Court

HL – House of Lords

CLR – Commonwealth Law Reports

All ER – All England Reports

NSWLR – New South Wales Law Reports

FLR – Federal Law Reports

VR – Victorian Reports

ASIC – Australian Securities and Investments Commission

BCC – British Company Cases

BCLC – Butterworths Company Law Cases

TLR – Times Law Reports

EBOLR – European Business Organization Law Review

PUCJ – Paul Usoro & Co Journals

NSWCCA – New South Wales Court Of Criminal Appeal