Navigating the New (Proposed) Disclosure Regime
[Ajitesh is a student at NALSAR University of Law.]
On 12 November 2022, SEBI released a consultation paper suggesting certain overhauls in the disclosure regime enshrined under the SEBI (Listing Obligations and Disclosure Requirements) Regulation 2015 (LODR Regulations).
Earlier, the companies proposing to be listed on the recognized stock exchanges had to enter into a listing agreement with the stock exchanges, and these agreements would contain obligations of companies prior to and post the listing and the disclosures required to be made with the stock exchanges. These agreements, although enforceable in the court, lacked regulatory backing. The timely disclosure of any material changes in the conditions of the company is an important step in the direction of investor protection. Therefore, in 2015, SEBI decided to convert the listing agreement into LODR Regulations.
The LODR Regulations have been amended from time to time and SEBI has recently proposed some major changes in the regulations. This article will attempt to briefly explore the major changes and the implications of these proposals.
The Rationale for the Consultation Paper
SEBI observed that there have been recent complaints regarding inaccurate and inadequate disclosures. It was also observed that despite the timelines mentioned across the LODR Regulations, there have often been complaints regarding delayed disclosures.
While Part A of Schedule III of the LODR Regulations lists the events that are deemed to be material and require disclosure, Part B of the same schedule requires disclosure of the events on reaching the materiality threshold, determined on the basis of the materiality policy (that the companies are required to formulate in accordance with Regulation 30(4) of LODR Regulations). The absence of the clearly laid out standards for determination of the materiality threshold would reasonably lead the companies to pay lip service to the regulations without fulfilling the ultimate objective thereof.
SEBI has, therefore, decided to come up with certain changes to deal with the issues of delayed and inadequate disclosures. While SEBI had the right objectives in mind, it might have gone a step too far in its endeavor, as has been explored in the article.
Presently, as mentioned above, companies need to formulate a materiality policy for the determination of material events. The KMPs are entrusted with the task of determining the material events based on the policy. Often, the policies only replicate the language of Part B (for instance, refer to the materiality policy of ICICI) thereby giving wide and unfettered discretion to KMPs in naming any event being material or not. This discretion could lead to many events that might be material and price sensitive going undisclosed.
SEBI has attempted to guide this discretion by stipulating that any event stipulated in Part B will be deemed to be material if the impact of the same in terms of values exceeds the lower of either 2% of turnover, or 2% of net worth, or 5% of the 3-year average of absolute value of profit/loss after tax.
While one may argue that this proposal is contrary to the notion of Part B Schedule III and completely takes away the discretion ensured by the materiality policy, the author believes that the same was in fact a necessary step towards the investors' protection. An argument can be made towards raising the materiality threshold. Sometimes, the profit, the turnover, or the net worth of the company is subjected to fluctuation in the ordinary course of business and may not be material. Accordingly, it may be considered to raise the materiality threshold to 5% or 10% of the turnover/net worth.
Verification of Market Rumors
SEBI noted that with the rise of online media, there is a prevalence of news about companies, and if the news is fake, it could create a false market sentiment. Therefore, it is proposed that the top 250 companies based on market capitalization would now have to respond to the market rumor that might have a material impact on the listed company.
It is noted that Regulation 30(11) already provides that the companies can respond to the market rumors at its discretion and further, the stock exchange may also request the listed companies to clarify or respond to the market rumors. The additional requirement as proposed arguably seems extensive and would add to the compliance costs of companies. As SEBI rightly pointed out, with the rise of online media, it has become harder to keep track of rumors; as such, the top 250 companies are more likely to make a media presence every now and then, and therefore, to keep up with all media rumors and reporting, such companies would incur heavy costs and would have to deploy considerable resources.
While the saying “the light of day (and perhaps the warmth of the sun) can be the effective regulators” holds true, it is also true that excessive sunlight is dangerous. This is to say that while timely disclosure is an important step towards investor protection, excessive disclosure is counterproductive. Every event does not need to be disclosed. The investors especially retail investors have the bandwidth to process the limited amount of information. This is one of the reasons that CRA ratings are useful in making investment decisions. The new regime proposed by SEBI may lead to information overload. As discussed previously, the qualitative threshold of 2% may be extremely low, which might result in excessive disclosures.
Similarly, SEBI also proposes to mandate the companies to disclose to the stock exchange any communication made by the officials of the company. It is interesting to note that this requirement is not qualified by the materiality threshold, and therefore, any communication would have to be reported. The officials of the companies, in course of their media presence, often make fleeting statements regarding the companies; the same may be immaterial and, if disclosed, would only lead to information overload. Therefore, SEBI should clarify the proposed amendment to limit the disclosure of the official communications made by officials by a materiality threshold.
The recent consultation paper, if and when adopted, would be a marked step in the disclosure regime in India. The changes suggested would add to the deemed disclosure in Part A, Schedule III and restrict the discretion of the companies in determining the materiality threshold. SEBI has also attempted to fine-tune the timelines for making the disclosure. The paper has discussed how SEBI, although motivated by the right concerns, has again overstepped or overcompensated.