Operational Challenges for Disclosures under the Revised Regime of SEBI LODR

Securities and Exchange Board of India (SEBI) has, in the recent past, introduced various progressive regulations for the protection of interest of investors in areas of insider trading, social media “finfluencers”, greater disclosures at the time of initial public offerings (IPOs), adoption of global Environmental, social, and corporate governance (ESG) mandates and more. In alignment with the said goal, SEBI also introduced the SEBI (Listing Obligations and Disclosure Requirement) (Second Amendment) Regulations, 2023 (Amendment) to improve the quality of disclosures and avoid information asymmetry.

SEBI had been dappling with the concerns over the information imbalance that was being generated by the disclosures being made by the listed entities under the earlier disclosure requirements under SEBI (Listing Obligations and Disclosure Requirements) Regulations (SEBI LODR). It was of the view that adequate disclosures are not being made and this is leading to a delayed price discovery of shares and lack of investor awareness of information that impacts the investors.

SEBI analysed the international practices on disclosure requirements and floated a consultation paper to invite comments from stakeholders on the revised objective materiality threshold and revised timelines, as well as the increased disclosure requirements from companies.

While the Amendment has brought a more objective approach to disclosures to be made by listed companies, there are various practical challenges that are still being faced by the companies in complying with the same, leading to several operational concerns.

In this article we will examine the practical challenges faced by the companies in disclosures, which require further clarifications from SEBI:

1. Objective criteria test and mandatory materiality thresholds.
2. Disclosure of litigations, disputes, and regulatory actions like search, imposition of penalty, etc.
3. Disclosures of guarantees and loan agreements.
4. Disclosures of fraud and default.
5. Disclosure of ratings — unsolicited ratings and repetitive maintenance of ratings.
6. Disclosure of agreements entered into by stakeholders/promoters.
7. Verification of rumours on mainstream media.
8. Disclosures to be made for events or information of the activities of subsidiary.
9. Turpitude of excessive disclosure versus consequence of non-disclosure under SEBI LODR.

10. Key takeaways.

Objective criteria for determination of materiality of information and events

The Amendment requires listed entities to make three types of disclosures of events/information:

(a) Events and information deemed to be material under Para A, Part A of Schedule III of SEBI LODR.

(b) Events and information under Para B, Schedule III which meet the materiality threshold under Regulation 30(4) of the SEBI LODR.

(c) Voluntary disclosures of events considered to be material by the Board of Directors.

The Amendment also require companies to make necessary changes to their materiality policy in such a way that they are aligned with the spirit of the regulation and do not dilute any requirements enshrined under LODR. Additionally, the materiality policy must assist employees in identifying material events for the purposes of disclosures.

Earlier, listed companies had the discretion to determine if an event/information was material or not. However, with the onset of the 2023 Amendment, the criteria for determination of materiality of a transaction has been made objective. Listed entities must now disclose all events and information which meet the threshold based on the “2-2-5” rule provided under Regulation 30(4) of the SEBI LODR¹.

Whilst the introduction of the objective materiality criterion brought about uniformity in disclosures to be made, the “lower-of” mechanism which includes absolute value of profit or loss has led to an asymmetry of disclosures having to be made by some companies. For example, companies having low turnovers or less profit/loss are compelled to now make disclosures of several insignificant events having extremely low value owing to the low materiality threshold.

In this backdrop, some significant amendments to SEBI LODR and the implementational constraints faced thereof by listed entities are encapsulated below:

Disclosures of litigation(s), disputes(s) and regulatory action(s)

Prior to the Amendment, all litigations, disputes, and regulatory actions formed part of Para B and were to be disclosed only if they were considered material in the opinion of Board of Directors.

However, with the onset of the Amendment, regulatory actions have been classified as “mandatory” disclosures under Para A and ligations/disputes under Para B have to be tested against the objective criterion of materiality.

(a) Regulatory actions

Under Para A of Schedule III, Entries 19 and 20 cover regulatory action(s) which are required to be disclosed by listed companies irrespective of the materiality threshold. Both entries cover action(s) by regulatory, statutory, enforcement authorities and judicial bodies against the listed entity or its directors, KMPs, promoter, subsidiary, and senior management, when in relation to the listed entity.

Under Entry 19 of Para A, companies are required to disclose initiation of certain action(s),namely, search and seizure, investigation under the Companies Act, 2013 and reopening of accounts under the Companies Act, 2013.

On the other hand, under Entry 20 of Para A, it is only the action(s) taken and orders passed with respect of events such as suspension, imposition of fine or penalty, closure of operations and other such serious disabilities that must be disclosed. Entry 20 also includes the term “any other similar action” thereby widening the scope of disclosures under the same.

The significant distinction between the two provisions is the stage of disclosure. While for events such as search and seizure, the disclosure shall be made at the stage of initiation of an action, an event of imposition of penalty disclosure shall be made only once action has been taken or order has been passed.

Although the provisions enlist the events that have to be disclosed irrespective of materiality, there exists considerable ambiguity as to the scope and extent of regulatory actions to be disclosed under Entries 19 and 20. For instance, there is limited clarification on the quantum of fines and penalties that should be disclosed. This has led to practical difficulties as it may not be feasible for companies to disclose every trivial fine and penalty levied on them. Similarly, the term “any other similar action” must be interpreted to ascertain the extent to which it applies, considering that the other events listed under Entry 20 pertain to disclosures of serious disabilities to business operations.

(b) Litigation(s) and disputes(s)

Entry 8 of Para B requires companies to disclose any pending litigations and disputes which exceed the materiality threshold, and where the outcome thereof might have an impact on the company. The SEBI Circular clarifies that any litigation or dispute (including an assessment, adjudication, arbitration, and conciliation²) that may have any impact and exceeds the materiality threshold must be disclosed.

With varying types of assessment, specifically in direct and indirect tax, a question arises on disclosure requirements of show-cause notice by authorities, order for tax assessments, property tax assessments, claims not involving money, etc.

Additionally, although a standalone litigation or dispute may not exceed the materiality threshold, the requirement of ascertaining materiality on a cumulative basis by SEBI has caused ambiguity as to the mechanism of consolidating such litigations, especially in taxation matters.

Another such question that companies are facing is the disclosure of updates and developments once an event or information has been disclosed.³ In addition to determining the materiality of an event, listed entities are also posed with the challenge of determining what developments thereafter are material and warrant a disclosure. These challenges have essentially created asymmetry of disclosures within listed entities.

Disclosures of guarantees and loan agreements

Companies are required to disclose guarantees and indemnities issued by them under Entry 11 of Para B, if they exceed the materiality threshold on a cumulative basis.

This has been a huge compliance challenge as it is a recurrent practice for companies to issue guarantees for their subsidiary and associate companies in addition to unrelated third parties and manner of cumulation is creating an information asymmetry. It also raises questions on disclosure of non-monetary guarantees, such as performance guarantees, as the materiality threshold cannot be applied to the same. Further, once these disclosures are made, the Income Tax and GST Departments will have readily available data to initiate scrutiny for the tax paid on such guarantee’s, based on the artificial valuation provisions of the respective act.

Similarly, loan agreements, both in the capacity of borrower and lender, are now required to be disclosed under Entry 5 of Para B, based on the materiality threshold. However, an exception has been provided to companies who enter into loan agreements as a part of their ordinary course of business. This raises questions on whether loans that are extended in the form of inter-corporate deposits are required to be disclosed under SEBI LODR or would they come within the purview of ordinary course of business of certain companies. It also raises the question of the intention of the authorities with respect to the extent of disclosure that is expected from the entities.

Disclosures of fraud and default

The Amendment introduced disclosure requirement of fraud and default by the company, its promoters, directors, senior management, subsidiaries and KMPs is a mandatory disclosure under Entry 6 of Para A. This means that irrespective of the quantum of value involved, disclosure is required.

However, the regulation has not elaborated on what would constitute as a “trigger event” for disclosure of such fraud/default. Many companies are faced with the challenge of determining the appropriate stage at which a fraud must be disclosed. Whether fraud is to be disclosed on the receipt of a mere notice alleging a fraud or would have to be disclosed only upon a Disciplinary Committee/judicial forums declaration of a fraudulent activity having been undertaken are practical challenges faced by the companies.

Other significant disclosure requirements

Disclosure of rating: The Amendment in SEBI LODR introduced the requirement of disclosure of any new ratings in addition to revision in ratings. However, there is no clarity of the institutions, agencies or authorities whose ratings are covered under the same and neither is there any clarity on whether revision in rating is to include reassessment of rating wherein the same rating is maintained on a year-on-year basis.

Agreements entered into by stakeholders and promoters: Similarly, newly inserted Entry 5-A of Para A requires companies to disclose any agreements entered into by their shareholders, promoters, subsidiaries, etc. which may impact their management or control, or create any restriction or liability. A preceding step to this is the mandatory disclosure by the abovestated personnel, who are parties to the “specified agreements” to the listed entity about the agreement to which such a listed entity is not a party. As per Regulation 30-A, such a disclosure is to be made within 2 working days of entering into such agreements or signing an agreement to enter into such agreements. These provisions increase the obligation of companies to ensure constant scrutiny and vigilance over the acts of personnel concerned, over and above their own increased quantum of disclosures.

Verification of rumours: Another such provision which severely increases the requirement of entities to keep checks and balances and ensure vigilance is the verification of rumours under Regulation 30(11). This new proviso now requires top 100 listed companies (with effect from 1-10-2023) and thereafter the top 250 listed entities (with effect from 1-4-2024) to promptly deny, confirm or provide clarifications with respect to reported events and information on mainstream media, within 24 hours. The process of keeping track of ever such rumour on mainstream media is a cumbersome process for most companies and will increase the chance of misstep of compliance.

Disclosures for subsidiary companies: In addition to the increased quantum of disclosures and uncertainties that listed entities are striving to overcome for their own disclosures, they are also obligated to make disclosures for their subsidiaries under Regulation 30(9).

This disclosure requirement extends to all events and information under Paras A and B. However, in case of disclosures for subsidiaries, companies must apply their materiality threshold even for Para A events. Even though the general principle is that all events must be checked for materiality in case of disclosure for subsidiaries, the regulation contains certain exceptions for which disclosures for subsidiaries must be made irrespective of the threshold, for example, disclosures of action(s) taken under Entry 20, Para A.

Every organisation has a unique structure involving various subsidiaries which may be listed, unlisted, international, domestic, material, in multiple layers, etc. Accordingly, every listed entity is faced with a distinct disclosure requirement, specific to their organisational structure. It thus becomes necessary for companies to develop a mechanism to keep track of activities undertaken by their subsidiaries and to ensure timely disclosures under SEBI LODR.

Turpitude of excessive disclosure versus consequence of non-disclosure under SEBI LODR

As discussed, the Amendment was introduced to bring an objective criterion for disclosure requirements so as to reduce information asymmetry about listed entities. However, increased and broad disclosure heads without granular details on the type of disclosure required from the company has created further disorientation on information that is considered to be material and that is required to be disclosed by listed entities.

This is leading to an inclination for the more prudent listed companies to indulge in excessive disclosure. While it may be perceived that excessive disclosure is beneficial to the interest of the investors and in line with the objective of SEBI LODR, this may not be true. Excessive disclosures can create an information dump with the investors drawing their attention away from what is truly material and important. For instance, disclosure of frivolous show-cause notices received by the company without receiving any finality or routine inter-company transactions which may have no impact on the investors.

There is also the concern of the privacy of companies being maintained and businesses being able to exercise internal control for the functioning of the business without having to disclose every strategic move being undertaken by the company. For instance, verification of rumours, while intended to benefit the investors, may have adverse effects on sensitive strategic alliances or first mover advantage being attempted in privacy of business.

However non-disclosure of information can lead to hefty penalties of rupees one lakh per day for delay or one crore, whichever is lesser under Section 23-A of the Securities Contracts (Regulation) Act, 1956 and Section 15-A(b) of the SEBI Act, 1992. This was noted in the case of the NDTV adjudicating order⁴, where penalty was levied for non-disclosure of an income tax order by the company.

Thus, it is imperative to exercise caution in interpretation of disclosure requirements under SEBI LODR. An attempt should be made to have uniform practices and standard views across industries with respect to disclosures. This can be achieved if questions of interpretation are seen considering all related laws applicable to a particular event. Not only will this maintain uniformity, but it will also ensure the correct extent of disclosures by a company resulting in a balance between investors’ interest and statutory compliance requirements.

Key takeaways

Some action points that companies may adopt to curb operational challenges faced for disclosure requirements under SEBI LODR are as under:

(a) Review the materiality policy and develop standard operating procedures (SOPs) to maintain uniformity in disclosures over the years.

(b) Companies having offices in different locations to centrally align their disclosure policies across branches.

(c) Industry specific events/information must be disclosed in a manner as is collaboratively decided and implemented by industry players.

(d) Train the employees and other stakeholders to identify events/information that would require disclosures so that the strict timelines of the Amendment can be adhered to.