IMPORTANCE OF DISCLOSURE REQUIREMENTS VIS-À-VIS INVESTOR’S PROTECTION DURING THE COVID-19 PANDEMIC
This post has been authored by Anurag Shah, a B.B.A. LL.B candidate at the School of Law, Christ (deemed to be University).
Any financial market can only gain the trust of investors by decreasing the information asymmetry between the investors and the market. Even though free-market proponents argue that most of the time the market discipline ensures that the players in the market provide information to the investors, more often than not it is the regulators who have to ensure that the relevant information reaches the stakeholders. This is done through disclosure requirements. Disclosure requirements can be understood as the requirement to timely inform the investors of everything that might have an effect on the decisions of the investors. One of the most important roles of the regulators of financial markets is to ensure that these disclosures are not cherry-picked to benefit someone. Therefore, the regulators try to decrease the information asymmetry in the market by mandating the disclosure of material information.[i]
The importance of disclosure requirements was highlighted by Securities Appellate Tribunal [hereinafter "SAT"] in the case of Milan Mahendra Securities Pvt. Ltd. vs. SEBI.[ii] SAT stated that disclosures under the SEBI Regulations serve a very important purpose in the market. If a company fails to make a relevant disclosure at any given point of time, it correspondingly means that an investor was deprived of this information and this asymmetry would have impacted his choices. The tribunal went forward to state that the requirement to disclose information in the market is imperative to ensure transparency in the transaction and it also makes it possible for the regulator to effectively monitor transactions in the market.
To ensure proper adherence to these requirements, the adjudicatory body of the Indian securities market has time and again imposed a penalty on defaulters. SAT in the matters of Akriti Global Traders Ltd. vs. SEBI, while levying penalty on a company for the delay in making disclosures, stated that penal liability arises as soon as the disclosure requirements are violated and that the liability is not dependent upon the intentions of the parties or any loss or gain accrued because of such non-disclosure.[iii] The primary reason to keep these requirements stringent is to ensure that an investor makes an informed choice while entering into a transaction.
Disclosure requirements by the SEBI in the case of happening of an event
With regard to disclosure requirements, one of the most important regulations is Regulation 30 of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015[iv] (hereinafter "LODR"). Under Reg. (30) of LODR, a listed entity is mandatorily required to disclose material information, that the Board of Directors deem fit. The regulation then goes on forward to substantiate what would be considered as a material fact. The same is elaborated upon under Regulation (30) (4) (i) of LODR. As per this regulation, the listed entities shall consider the following aspects while deciding the materiality of an event: Firstly, whether the omission of such an event or circumstance would lead to a change of the information already available to the public, secondly, whether the information would result in a significant market reaction if disclosed and finally anything that the Board of Directors deem as material.
There is also a time-bound regulation for the disclosure under Regulation 30, which is that the listed entity should disclose such material information to the stock exchanges ‘as soon as possible’ and not later than 24 hours from the occurrence of such an event. Moreover, Regulation 30 suo moto deems the events mentioned under Part A of Schedule III of LODR as material events, and therefore, disclosing the same is mandatory. The nature of events under Part B and C of Schedule III shall be decided while giving due consideration of the three aspects mentioned above. [v]
Similarly, under Regulation 51(1) of the LODR, companies must disclose all the price-sensitive information, or that has a bearing on the performance of the listed entity, or any event that would have an effect upon the payment of interests or dividends of non-convertibles.[vi]Therefore, these are the relevant disclosures that a listed company has to undertake to inform the investors and the market about the impact of such events on the future of the entity.
SEBI’s Circular for disclosure related to COVID-19
SEBI has always been at the front to protect the interests of the investors and to keep the market transparent and responsible. During these pandemic stricken times, it has become imperative for SEBI to ensure that the trust of the investors is maintained in the financial markets. The market has already started to experience the effect of the pandemic which can be seen in the high redemption pressure in the mutual funds' industry.[vii] However, SEBI again came to restore the trust of the investors by keeping a check on the risk exposure and liquidity issues of the mutual funds.[viii]
To ensure the trust of the players in the stock markets, SEBI on 20th May 2020 issued a circular to all the listed entities, recognized stock exchanges, and the depositories.[ix] The circular advised all the listed entities to disclose the impact of COVID-19 pandemic and the resultant lockdown on their functioning. The power to issue this circular was derived from Section 11(1) of the Securities and Exchange Board of India Act, 1992 read with Regulation 101 of the LODR.
The circular advises the listed entities to disclose material facts with regard to the COVID-19 under Regulation 30(3) of the LODR. Clause 6 of the Para B of Part A of Schedule III of the LODR Regulation provides for events such as “Disruption of operations of any one or more units or division of the listed entity due to natural calamity (earthquake, flood, fire, etc.), force majeure or events such as strikes, lockouts, etc.” Therefore, as mentioned earlier, any event mentioned under Part B of Schedule III shall be considered along with the materiality test provided in Regulation 30(4) of the LODR. The entities are also bound to disclose the effects as per the SEBI vide Circular No. CIR/CFD/CMD/4/2015 dated September 9, 2015[x]. Annexure I of the above-stated circular provides for the details to be disclosed in cases of disruptions of operations due to natural calamity, force majeure, and other events. Also, the impact on non-convertibles under Regulation 51(1) of LODR should also be disclosed.
Among other things, SEBI advises the listed entities to evaluate and inform about the impact of the pandemic and the resultant lockdown on their financial status and activities. The circular goes on to recommend some sample disclosures related to the pandemic which includes inter alia the liquidity position of the entities, operations impacted because of the lockdown, demand and supply of their products and services, ability to service debt and other financial arrangements, and the evaluation of the impact of the pandemic. The list is not exhaustive and the entities should disclose all the material facts. The circular also stated that as of May 05, 2020, most of the listed entities had not made these disclosures. Therefore, the circular is a prime example of the resolutions and steps by SEBI to protect the investor’s interests and to control information asymmetry.
Even though the move by SEBI is praiseworthy and much needed, the entities themselves must come forward and ensure proper and continuous disclosures to create market discipline. During these difficult times, investors are more likely to have distrust and confusion with regard to their transactions, and information asymmetry might worsen the situation. It may compel the investors to take out their investments leading to an unstable illiquid market. To prevent this, listed entities should give due regard to the principles of transparency and disclosures given under Regulation 4(2) of the LODR. Doing this would instill confidence amongst the investors that the market would perform well even in these testing times.
[i] Kerry Back, Kevin Crotty, Identifying Information Asymmetry in the securities market, Review of Financial Studies, Vol. 31, No. 6, pp. 2277–2325 available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2565216
[ii] Milan Mahendra Securities Pvt. Ltd. vs. SEBI, Appeal No. 66 of 2013, available at https://www.sebi.gov.in/satorders/milansatorder.html
[iii] Akriti Global Traders Ltd. vs. SEBI, Appeal No. 303 of 2017, available at http://sat.gov.in/english/pdf/E2018_JO2017331.PDF
[iv] Regulation 30, SEBI (Listing Obligations and Disclosure Requirements), 2015.
[v]India: Disclosures Under SEBI (Listing And Disclosure) Regulations, 2015, available at https://www.mondaq.com/india/securities/434208/disclosures-under-sebi-listing-and-disclosure-regulations-2015
[vi] Regulation 51, SEBI (Listing Obligations and Disclosure Requirements), 2015
[vii] Franklin fallout: Credit risk funds to face redemption pressure, say experts. Economic Times, available at https://economictimes.indiatimes.com/mf/analysis/franklin-fallout-credit-risk-funds-to-face-redemption-pressure-say-experts/articleshow/75353744.cms?from=mdr
[viii] SEBI tightens scrutiny of debt funds' risk exposure, liquidity, available at https://www.livemint.com/news/india/sebi-raises-scrutiny-of-redemption-pressure-and-concentration-risk-in-debt-funds-11588162658772.html
[ix] SEBI Circular dated 20th May 2020, available at https://www.sebi.gov.in/legal/circulars/may-2020/advisory-on-disclosure-of-material-impact-of-covid-19-pandemic-on-listed-entities-under-sebi-listing-obligations-and-disclosure-requirements-regulations-2015_46688.html
[x] SEBI Continuous Discloser requirements for listed entities, 2015, available at https://www1.nseindia.com/content/equities/SEBI_Circ_09092015.pdf