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Blurring the Line between Mandatory and Discretionary Disclosures: SEBI proposes to modify Disclosure Requirements for Listed Entities

Sandeep Parekh

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I have a piece with Rahul Das and Navneeta Shankar on SEBI’s proposal to modify listing obligations in yesterday’s Financial Express. The full piece is available below:

The Securities and Exchange Board of India has time and again emphasised the need for listed companies to ensure adequate and timely disclosure of material information/events to investors to maintain transparency and fairness in the market. Regulation 30 of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 aims to achieve this by mandating the disclosure of certain events that are deemed to be material. For instance, any change in the directors, CEO, CFO, auditor and compliance officer of a company has to be mandatorily disclosed to the public. At the same time, the LODR Regulations provides another list of events for which companies have been granted the liberty to exercise their discretion in determining whether such events are material enough to be disclosed. To guide companies, the LODR Regulations provide broad guidelines to determine the materiality of events, based on which companies must frame their materiality policy.  For instance, a company can exercise its discretion to determine whether a particular regulatory action against it is material enough in impact so as to be disclosed to the public.

However, in the recent past, SEBI has observed an increase in complaints regarding inadequate and delayed disclosures as well as non-compliance with the prescribed timelines for disclosures by companies. This becomes a cause of concern since in today’s digital age, where information is readily available, it has become imperative for listed companies to promptly verify market rumours and disseminate material information to investors in an accurate and timely manner. At the same time, instead of building a comprehensive materiality policy, several listed companies without any application of mind have merely reproduced the guidelines for materiality prescribed by SEBI in the LODR Regulations.

Being concerned by the same and to keep pace with the changing market dynamics, SEBI recently issued a consultation paper proposing amendments to the LODR Regulations. Broadly, SEBI has proposed to i) expand the list of deemed material events that have to be mandatorily disclosed; ii) provide different timelines for disclosure of events and iii) curtail the discretion that is presently enjoyed by companies in determining whether a particular information/event would be material enough to be disclosed to the public.

The consultation paper highlights that, at present, several entities do not disclose relevant events on the ground that the information is not material as per the company’s materiality policy. Moreover, as many companies adopt a generic materiality policy, it provides them with ample leeway in deciding whether to disclose an event or not. To address this mischief, SEBI has proposed to insert a quantitative threshold to determine the materiality of events with respect to information/events which do not fall in the category of deemed material events. It is proposed that events whose threshold value or expected impact in terms of value is more than the lower of either 2% of turnover, or 2% of net worth, or5% of the 3 year average of the absolute value of profit/loss after tax, as per the last 3 audited financial statements of the company, will have to be disclosed.

While the intent to bring about uniformity and transparency in company disclosures is laudable, the proposed quantitative threshold will blur the line between mandatory and discretionary disclosures and dilute the power of listed companies to independently determine the materiality of events, which in itself is a subjective endeavour. Further, a mere 2% threshold will lead to companies making excessive and inconsequential disclosures. This will make it especially difficult for retail investors to distinguish between material information and that which is mundane and redundant. As an alternative, for information which is not deemed material, a company should be given the discretion to determine its materiality on a case-to-case basis where a reasonable quantitative threshold determined by the listed company itself could act as a guiding factor.

The paper has also proposed to reduce the timelines for reporting from 24 hours to 12 hours and 30minutes in certain cases on the premise that in the present age of digital communication and widespread usage of social media, information permeates very fast. The proposal appears to disregard the fact that material events may require time to be identified and thereafter escalated from the ground-level employees to the chief compliance officer for appropriate action. Sufficient time should be provided to listed companies to verify and determine material information and thereafter disseminate it to the public. This is quintessential for improving the appropriateness, accuracy and credibility of the information being disclosed. A drastic time constraint such as the one proposed may lead to hasty disclosures with incorrect information being disclosed or material information being left out.

Additionally, considerable emphasis has been put on the need to verify market rumours and speculations in order to avoid false market sentiments and impact on the share price of companies. The consultation paper proposes mandatory verification of market rumours in the mainstream media by the top 250 listed companies. However, mandating companies to outrightly confirm or deny any reported event or information may lead to premature disclosures or leakage of trade secrets and may hamper ongoing business negotiations. Entire deals may collapse because of a miscreant employee leaking rumours, which then confirms a particular negotiation. Further, given the wide range of mainstream media and the volume of misinformation available on these platforms, it is impossible for entities to keep a tab on every rumour surrounding them and to outrightly confirm or deny such rumours at the same time. In brief, this is a poor idea, discussed and rejected in almost all jurisdictions.

With the adoption of advanced technology, cyber security incidents or breaches and loss of data/documents have become major concerns. Keeping this in mind, SEBI has proposed mandating a detailed disclosure of such events as a part of the quarterly compliance report of the entity, highlighting the root cause analysis and the remedial measures taken. This will not only ensure timely corrective actions by the listed entity, but will also address any unrest among the investors and uncertainty in the market. While immediate disclosures may not be desirable owing to the vulnerability of the entity and its data, a brief acknowledgement of the incident post the passage of reasonable time is necessary and would serve the underlying intention of ensuring transparency among the investors.

The paper has also recommended the disclosure of such delay or default in payment of fines, penalties, etc. to any regulatory or judicial authority that may be material for investors. Further, it has been proposed that in cases of resignation of key managerial personnel or a director of a listed entity, the letter of resignation along with the detailed reasons for resignation must be mandatorily disclosed to the stock exchanges. Additionally, where the managing director or the chief executive officer of a listed entity is unavailable to consistently fulfil their role for over a month, such information is to be necessarily revealed to the investors. Apart from achieving transparency, these proposals would go a long way in inducing a sense of trust and confidence among the investors for listed entities.

Overall, certain amendments proposed in the paper are increasingly relevant to keep up with the changing market dynamics and to adapt to the pace of dissemination of information in the present day and age. While it is paramount that listed entities should strive to disclose material events to investors promptly, it is essential to strike a balance between ensuring adequate and timely disclosure of material events and not bombarding investors with pre-mature and inconsequential information. Timelines for disclosure should not be shortened unreasonably and companies should be given the flexibility to set their own realistic quantitative thresholds to determine the materiality of events. It is key that each proposal of the Board is viewed with the aim to ensure disclosure of only such information that is vital while subjecting the listed entities to low compliance burdens. In fact, it is time SEBI modified the current disclosure norms to exempt certain kinds of acquisitions even if they are material, so that deals do not get jeopardised through front running by the market, altering the price of the target adversely.

(This article was first published in Financial Express)