Author: Aditya Rao, II year, NALSAR University of Law
Introduction
The Securities and Exchange Board of India (SEBI), India’s apex market regulator has notified the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2022, amending the disclosure requirements for listed companies. Aimed at tackling inaccurate and often misleading information released through formal channels by listed entities, this amendment places extensive obligations on such corporates that also appear retrospective in nature. A welcome move, considering the increasing risks in the Indian market, the amendment seeks to do good the loopholes that have plagued the disclosure system in India for years.
Significance- More scrutiny on disclosures
The importance of a swift, robust and reliable system of disclosures cannot be stressed enough. To this end, a comparison with the US equivalent regulations is required. A ver recent example is the US Securities and Exchange Commission (SEC) announcing charges filed against Facebook Inc. in 2019 for making “misleading disclosures” in the quarterly filings regarding risks of misusing public user data. It was alleged that the 7th biggest company in market capitalisation shrieked off these issues as being ‘merely hypothetical’.
In periodic reports, US listed companies are required to submit to the SEC, details of risks perceived by management. This is similar to Regulation 35 of the SEBI Listing Regulations which prescribe an ‘Annual information Memorandum’ to be submitted by listed corporates. Unfortunately the 2015 Rules have not been effectuated yet. The tough regulations instituted after the infamous Enron bankruptcy, did away with ‘selective’ disclosure of statements and investor details.
The new regulations are a welcome move in this regard, and it is hoped that it will adequately deal with the misinformation riven in the market and not place too much compliance burden to hinder business altogether. Section 52(1) was amended to include the obligation to disclose financial results of the last quarter of the financial year along with the present quarter, with a time limit of 60 days prescribed.
Higher oversight with lessor compliance burden
Sub-regulation 2(d) was amended to enable entities requiring audits by the Comptroller and Auditor General of India, to only submit a limited review report by the CAG or any accountant, along with the unaudited reports to the Exchange. This would reduce the burden effectively to timely get audited completely, but being substituted by a limited review filing. By amending 2(f), asset and liability reports are separately filed apart from the consolidated financial results, resulting in a more comprehensive check system.
Timelines
One significant change brought about by the amendments was to align the timings of filing the reports. The statement of usage of security proceeds and other reporting have been aligned with the quarterly reports, giving the Board ample opportunity to scrutinise effectively. The retrospective character as pointed out earlier stems from the new requirement for the top 250 listed companies to consider the information prevalent in media deemed to be “having a material effect” and formally and in public confirm or deny them. This will ensure accountability to these entities, considering how lack of liability has led to lack lustre and often malafide sources of information that directly impact price valuations and index values.
The new regulations highlight the move away from traditional obligatory impositions like penalties and fines, to burden of duty for listed entities. It has opened an array of ‘material events’ that require disclosure to the exchange and general public. This could include addition and restructuring of senior management, or the CEO unable to perform duties at a moment in time, they must also be back by material evidence like letters of resignations or other documents to confirm the credibility.
While the downside is that price values may not be as steady and become highly contingent on various events reported, which might not be as material, and it is argued that this is antagonistic to the interests of the investors. This is far from true. Comprehensive and deep researched disclosure requirements will ensure that even minority shareholders share the responsibility and awareness as others who may be more involved in senior meetings. Awareness of the business analytics will therefore ensure that investors make the best decisions regarding their stake in the enterprise they paid to be part of.
Discretion- Qualitative to Quantitative
International ventures, particularly from the US and UK often establish funds in India by treading extremely slowly, vary of the immense risk and murkiness that the Indian market is known for. The new amendment applies learnings from the SEC in eliminating selective reporting. By statutorily imposing requirements from every aspect of a company’s life, the SEBI has ensured transparency is restored in the Indian market. This makes legal due diligence streamlined. The change in terminology from “may” to “must” reflects just that.
Companies now are mandated to provide complete data regarding any enforcement proceedings instituted against directors and promoters, who may not necessarily be part of the business “material” plan. This could bring risks and scare away creditors, or even lead to highly leveraged credit requirements. It is argued that this necessarily reverses the benefits that the IBC 2016 brought to the Indian debtors, and could hinder profitable ventures, straining investor objectives. This is entirely unreasonable. The higher requirements have only extended to the top 250 listed corporates, far from the saga of investment funds and private companies that are free to shirk off risk by keeping material information confidential.
The element of discretion therefore, is eliminated the moment this materiality is breached for the following financial information- 1. Two percent of the annual turnover, 2. Two percent of the annual net worth, 3. Five percent of the three year average of absolute value of profits or loss (PoL)
But what is essential to observe is that it is almost common practice for bigger corporates to even fortify their reports with beneficial information, but secluding the debt ridden truths in backhanded unofficial meetings between larger shareholders. Such requirements adequately remedy these issues. The wide scope of reporting may not only extend to disclose of cybersecurity breaches and subsequent losses of data, but also Environmental Social Governance (ESG) SASB Standards. The consultation paper is still pending for comments. A conclusive framework is awaited still.
IPO Blunders- More supervision
The recent crumbling of Nykaa and Paytm stock after a tremendous over inflated IPO has also been scrutinised by the SEBI. Promoters, to make maximum profits, take a company public making various promises and conceal material downside factors only play out in the secondary market to the common public. Placing a pre inspection requirement, the market regulator seeks to alleviate potential losses common investors face. The SEBI in another amendment has mandated filing of three copies of the pre-filed draft with the Board, which shall be matched with disclosure statements, before being released in the public exchange.
This has been criticised stating it takes away the autonomy of entities, banks and underwriters by acting as an impediment to the valuations of the stock. Similar to other objections, this is baseless. Every public investor subscribing to a company, even an investment manager conducting due diligence, is entitled to look through authenticated financial statements before making a sound decision. Concealment of material information while a stock jumps public could amount to misrepresentation as understood under the Indian contract Act, 1956.
Conclusion
While it is correct that any regulatory measure is bound to act as impediment to market ventures, it is also common law principle that listed companies owe a fiduciary relation to their investors, and therefore awareness and understanding of material events within the operations or management needs to be instilled through diligent and stringent disclosure requirements, and it is yet to see if the SEBI framework really meets these objectives in practice.