BY HARSHIT SINGH AND AKSHATA MODI, THIRD-YEAR STUDENTS AT GNLU, GUJARAT
A robust and continuous disclosure mechanism for listed entities is quintessential to ensure transparency and timely dissemination of material information and events. Such a mechanism is necessary to maintain the efficiency of capital markets. A strong disclosure regime also helps to reduce any information asymmetry among market participants and enables them to be levelled at the same footing. Regulation 30 of SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 [“SEBI LODR Regulations” or “Regulations”] governs the disclosure of material events and information by listed entities to stock exchanges. Disclosures under this regulation are classified into compulsory disclosures and discretionary disclosures.
Under Regulation 30(2) of the SEBI LODR Regulations, events specified in paragraph A of Part A of Schedule III are deemed to be material events and are mandatorily required to be disclosed by listed entities. Such events include matters related to mergers and acquisitions, insolvency, capital structuring and outcomes of the board of directors’ meetings, among others. At the same time, disclosure of events listed in paragraph B of Part A of Schedule III is discretionary and is determined by the materiality policy of the companies.
To review and strengthen the disclosure requirements of listed entities, the Securities & Exchange Board of India [“SEBI”] has recently issued a consultation paper [“Consultation Paper”], proposing drastic changes to Regulation 30 of the SEBI LODR Regulations. The Consultation Paper comes against the backdrop of several complaints received by SEBI in the past about delayed, inaccurate and misleading disclosures being done by the listed entities. Through this article, the authors aim to discuss the key changes proposed by the consultation paper and analyse their probable impact on the compliance burden of listed entities.
B. Key changes proposed in Regulation 30 of the SEBI LODR Regulations
1. Setting up a quantitative criterion for determining materiality
The Regulations currently prescribe for events and information falling under paragraph A of Part A of Schedule III to be classified as material events, and for their disclosure to be mandatory. However, disclosure of events falling under paragraph B is discretionary and would be determined based on the ‘materiality policy’ of the entity, as provided under Regulation 30(4). Presently, the regulation stipulates for a listed entity to consider the following criteria while determining the materiality of events:
- the omission of an event will or is likely to result in alteration or discontinuity of information already publicly available, or
- the omission of an event is likely to cause a significant market reaction if such omission comes to light later.
As per the current norm, events or information falling into either of the categories shall be deemed to be material.
Regulation 30(4)(c) confers upon the board of directors wide discretionary powers for determination and disclosure of material events. Through the Consultation Paper, SEBI proposes to move towards an objective, quantitative and non-discretionary threshold for determining the materiality of events and information. The proposed changes aim to bring uniformity to the materiality policy across all listed entities and limit the discretion conferred upon the board for disclosure of events specified under para B. SEBI has suggested the three below-mentioned minimum thresholds for determination, upon fulfilment of any one of which, an event or information would be considered material [“Materiality Test”].
- Two per cent of turnover as per the last audited financial statements;
- Two per cent of net worth as per the last audited financial statements;
- Five per cent of the average profit or loss of the past three years.
The Consultation Paper proposes to add these thresholds to Regulation 30(4)(i) and accordingly, make it mandatory for the materiality policy of all listed entities to provide for these triggers. Furthermore, dilution of these thresholds by the entities would be prohibited, and strict adherence would be prescribed for the determination of materiality.
2. Reduction in disclosure making timeframes
Regulation 30(6) presently mandates all listed entities to disclose events or information falling under Part A of Schedule III to stock exchanges no later than twenty-four hours from the occurrence of such event or information. However, SEBI has recorded several instances in the past whereby the entity made the disclosure at the last hour after such information had already been publicly circulated through media. To address this delay in disclosure, the Consultation Paper has proposed to reduce the twenty-four-hour disclosure time limit to twelve hours. Further, it has also been recommended that the disclosure of events or information emanating from the board of directors’ meetings should be made within thirty minutes from the end of such meeting.
3. Verification of rumours
Presently, Regulation 30(11) provides that a listed entity on its own, may refute or confirm any rumour or reported market information; however, the same is not obligatory. SEBI believes it to be essential to verify rumours in order to avoid any false market sentiment leading to widespread speculation and price manipulation. As a result, through the Consultation Paper, SEBI has proposed to make it mandatory for the top 250 listed entities (by market capitalisation) to verify “any market rumour, or reported event or information which may have a material effect on such entity”.
1. Rigidity in the quantitative disclosure criteria and potential overflow of information
Setting up quantitative criteria for determining the materiality of events significantly reduces the discretion of listed entities for the disclosure of events and information. It creates a more objective disclosure regime, resulting in better clarity for investors and for the listed entities. However, establishing the Materiality Test may lead to the disclosure of wide-ranging events and information to the public. Such disclosures may be redundant and may not be having any significant or material impact on the entity’s operations or business. An overflow of information about a listed entity could lead to a greater degree of speculation in the market, thus, sharply affecting the stock prices of such an entity. Additionally, the proposed materiality threshold is too low and might result in a company disseminating a large volume of superfluous information through its disclosures. Most of all, it gives rise to a greater probability of crucial disclosures being bypassed by investors amidst an overflow of information to the public, which potentially makes the disclosures counter-productive.
2. Verification of market rumours could lead to premature disclosure of sensitive information
Verifying any information or event reported in print or digital media may be challenging for companies. Such challenges arise because while conforming or refuting any rumour, the listed entity will have to take a stance on a matter, whichcould be premature and might not have crystallised into a disclosure requirement otherwise. Verifying all rumours reported by media could be particularly challenging for companies undergoing mergers and acquisitions [“M&A”]. In public M&A transactions, price certainty and success of a deal are contingent on the deal’s confidentiality. This is because these transactions must take place above the floor price prescribed by SEBI, and this floor price largely depends on the historical price movement of the stock. As per the proposed changes, if there is any rumour in the media about the M&A transaction, the company would be compelled to confirm such speculation and be forced to divulge details of a half-baked deal. Such disclosure would drive the stock prices too high and jeopardise the deal’s commercial viability.
3. Potential disclosures of incomplete Unpublished Price Sensitive Information
Another concern is the premature disclosure of Unpublished Price Sensitive Information [“UPSI”], which could prove to be counter-productive to the public interest. SEBI (Prohibition of Insider Trading) Regulations, 2015 mandates for UPSI to be disclosed upon becoming concrete and credible. Disclosure of UPSI at the correct time is essential to ensure information symmetry in the market and to minimise price speculation. However, the Consultation Paper proposes to make it mandatory for a company to disclose and confirm information regarding any market rumours, even on deals which are currently in progress and are not yet confirmed. There will be sharp reactions in the market to any such disclosures, and the shareholders consequentially might lose if the deal falls through. Furthermore, by verifying market rumours, the company might disclose an incomplete UPSI, which would not be in the best interest of the investors.
The proposed changes by SEBI would substantially increase the compliance burden of listed entities. It could lead to a tsunami of disclosures and overburden investors with needless information which may not carry any material impact on the entity’s operations. The consultation paper further proposes for the top 250 listed companies to corroborate market rumours. This would make disclosures considerably onerous and would require companies to beef up their existing capacities to track and reply to all media reports. On implementation, the proposed amendments could cause companies to reconsider their listing plans. It could also potentially inhibit the growth of capital markets. Therefore, it is the view of the authors that SEBI should reconsider the changes proposed in the Consultation Paper and attempt to strike a balance between protecting investors’ interests and the compliance burden of listed entities.