WHEN THE SCRIPT IS DECEPTIVE: MISUSE OF TOEHOLD ACQUISITIONS IN PRIVATE

PLACEMENT BIDDING

- Filzah Belal

Filzah Belal is a final year undergraduate law student at National Law University and Judicial
Academy, Assam.

The capital market is a free platform for trading in securities, but what happens when external
forces act on the market? It influences the prices of the shares, but not at all in an organic way.
In this article, I will discuss one such situation when the prices are influenced by external forces
in the share market to gain unfair profits – when prospective acquirers gain ‘toehold
acquisitions’ in order to enjoy an upper hand in private placement procedure and do so by
increasing activity in the script of the company which inorganically increases the shares’ price.
Toehold acquisitions are those acquisitions which are done by a prospective investor. These
acquisitions are usually done so that the target company knows that the investor is interested
in investing Toehold acquisitions are often small acquisitions (hence the reference of the term
to the size of a ‘toe’), but they are significant enough to come to the attention of the target
company.

In certain situations, toehold acquisitions may become an unfair trade practice. The regulator
of the capital market in India is called the Securities and Exchange Board of India (SEBI). The
SEBI (Prohibition of Fraudulent and Unfair Trade Practices) Regulations, 2003 (hereinafter,
the PFUTP Regulations, 2003) under Clause 3(a) provides that no person shall directly or
indirectly buy, sell, or otherwise deal in securities in a fraudulent manner. The definition of
fraud under the regulation includes “an active concealment of a fact by a person having
knowledge or belief of the fact in a deceitful manner while dealing in securities.” Here the term
to be emphasized upon is in a “deceitful manner.”

When a prospective investor acquires a toehold in the target company, he can buy all the shares
at once from the share market at once. However, when he chooses to buy these shares in
fragments, he increases the activity in the script of the target company. It falsely results in a
higher number of market activity in the shares [1] of the target company, thereby increasing
the share prices of the target company. This can be inferred as ‘price manipulation’ under the
PFUTP Regulations, 2003.
In SEBI v. Kishore R. Ajmera [2], the Hon'ble Supreme Court of India observed that, “The
proof of manipulation almost always depends on inferences drawn from a mass of factual
details. Findings must be gathered from patterns of a transaction, the nature of the transactions,
etc.” Therefore, to determine whether a party has made several transactions in the target
company to manipulate the share prices depends on the party’s intention.

Manipulation is intentional or willful conduct designed to deceive or defraud investors by

controlling or artificially inflating the price of securities [3]. Since the prospective investor
knows that he can buy all the shares at once instead of buying them in fragments, he shows
intent.

In a private placement, when a prospective investor acquires a toehold, it gives him an added
advantage over the other bidders. Toeholds are non-controlling equity stakes which can give
their owner the opportunity to interact with the target or its management in ways that are not
available to other bidders [4].

In such a situation, it gives the prospective investor double advantage –one, that he gets an
upper hand during the bidding procedure involved in a private placement; and second, if that
prospective bidder is selected, he gets unfair profits because of the increased share prices (done
manipulatively).

Toehold purchases are not negative in every context and are not per se invalidated by the law
at every instance. However, manipulatively increasing share prices can be done even without
the intent of gaining an upper hand during the private placement procedure. However, the one
constant about trading in capital markets is profit motive.

Although a genuine increase in the script of the company can also lead to an increase in share
prices, it cannot be called “manipulative” because it happened through the natural forces in the
market. In contrast, a toehold acquisition by way of multiple transactions done intentionally to
increase activity in the script of the company cannot be said to have happened by way of natural
forces in the market.

Moreover, it is detrimental to the interests of the other participants in the market. Not only does
the company look better because of increased share prices in front of its competitors, but the
company also attracts new investors to buy shares under the impression that higher share prices
will get them increased profits, which fades once the activity rate of the company’s script
returns to normal. In a similar way, it also gives higher hopes to the existing shareholders of
the company who may buy more shares as the increasing share prices may look promising,
again, only until the activity rate of the company’s script returns to normal. Therefore, toehold
acquisitions should not be used as a means to gain unfair profits and/or an upper hand in the
private placement process. The practise is unethical and legally questionable.

The opinions and views expressed in this publication are the opinions of the designated authors
and do not reflect the opinions or views of the Penn Undergraduate Law Journal, our staff, or
our clients.

[1] “SEBI v. Kishore R Ajmera: Voluminous Trading in Illiquid Scrips.” 2016. IndiaLaw LLP
Blog. November 23, 2016. https://www.indialaw.in/blog/blog/commercialcorporate/sebi-v-
kishore-ajmera-voluminous-trading-illiquid-scrips/#_ftn1.

[2] “Order of the Hon'ble Supreme Court, in the Matters of Kishore R. Ajmera, Ess Ess
Intermediaries Pvt. Ltd. & Other Tagged Matters.” 2016. SEBI. February 23, 2016.
https://www.sebi.gov.in/enforcement/orders/feb-2016/order-of-the-hon-ble-supreme-court-in-
the-matters-of-kishore-r-ajmera-ess-ess-intermediaries-pvt-ltd-and-other-tagged-
matters_31815.html.

[3] “Ernst & Ernst v. Hochfelder - 425 U.S. 185, 96 S. Ct. 1375 (1976).” n.d. Community.
Accessed October 31, 2019. https://www.lexisnexis.com/community/casebrief/p/casebrief-
ernst-ernst-v-hochfelder.

[4] Paul, Sertsios, and Giorgo. 2012. “Getting to Know Each Other: The Role of Toeholds in
Acquisitions.” SSRN. November 16, 2012. https://ssrn.com/abstract=2176481.