INTRODUCTION
In an attempt to enhance shareholders autonomy and awareness among investors, Securities and Exchange Board of India (“SEBI”) via June 2023 amendment introduced various changes to Regulation 30 of listing obligation disclosure requirement (“LODR”). Regulation 30provides that every listed entity must disclose material events/information. However, for the sake of brevity, the authors will deal with following amendments: the amendment to material events in Part A of Schedule III (“Deemed Material Bucket”), introduction of materiality threshold under Regulation 30(4) for items included in Part B of Part A of Schedule III (“Discretionary Material Bucket”), introduction of Regulation 30(11) requiring verification of market rumour.
Additionally, SEBI floated a consultation paper dated 28 December 2023 proposing amendment to Regulation 30(11) of LODR regulations. Presently, Regulation 30(11) requires every listed entity to either confirm or deny any market rumours which it deems material in terms of regulation 30. The proposed amendment aims to replace material event requirement under Regulation 30 to material price movement, as a criterion to verify market rumours.
The present article aims to analyse the trend adopted by SEBI under Regulation 30 with respect to disclosure of material event requirements against the backdrop of June 2023 amendments and suggestions proposed in the consultation paper. In essence, the piece explores, firstly, the meaning of materiality by taking reference from USA’s jurisprudence, secondly, compares the approaches adopted by Security Exchange Commission (“SEC”) and SEBI for regulation of disclosure of material information, and lastly, the nature of proposed amendment in the consultation paper.
UNDERSTANDING THE MEANING OF MATERIALITY: THE TWO-FOLD APPROACH
The materiality requirement, derived from common law fraud, serves as the lynchpin for the disclosure requirements under securities laws. In the niche of securities law, the threshold of materiality is used to determine which information, from a range of available data, must be disclosed by the listed entity to the public in order to meet the expectations of stakeholders. In India, materiality establishes the foundation for disclosure of information under LODR, however, the term “materiality” is not defined anywhere. Therefore, we must take aid from foreign jurisprudence for better understanding of ‘materiality’.
In USA, the term “material” is defined under the security laws as follows:
“when used to qualify a requirement for the furnishing of information as to any subject, [materiality] limits the information required to those matters to which an average prudent investor ought reasonably to be informed before purchasing the security registered”.
Plethora of decisions by USA Supreme Court including TSC Industries v Northway, Mills v Electric Auto and Halliburton Co. v. Erica have discussed materiality. In essence, materiality has been defined as information that a reasonable shareholder, while making a decision, might have deemed significant. The Supreme Court reiterated this materiality standard in case of Basic v. Levinson, emphasizing that determining whether a piece of information is material involves an inherently fact-specific assessment. Further, the very purpose of release of material information is to prevent management from burying shareholders in “avalanche of trivial information”. Therefore, there are two characteristics of materiality, 1) it is circumstantial since it depends upon the persisting facts and circumstances, 2)it has the capability to substantially affect the decision of investor.
Given, we have established above that not all information is material; therefore, in order to ascertain materiality of information, we shall delve into the approaches put forth by SEC viz., prescriptive-based approach and principal-based approach. The prescriptive requirements, employ quantifiable benchmarks to determine when disclosure is required, whereas, principles-based requirement, offer registrants the flexibility to decide the materiality of specific information and the method of disclosing said information. The SEC on numerous occasions has highlighted the importance of principle-based approach because it provides necessary discretion to the registrant and is adaptable to keep up with new and evolving concerns. Whereas, prescriptive based approach provides roaster of events accompanied by a materiality qualifier (quantitative threshold) for the disclosure purposes.
COMPARATIVE ANALYSIS OF APPROACHES ADOPTED BY SEC AND SEBI
Under the US Securities Act of 1933, Regulation S-K outlines reporting obligations for public companies in SEC filings i.e., regulatory documents that issuers of securities must submit for greater transparency. Recently, SEC introduced amendments to disclosure requirements, specifically, in items 101 and 102 under S-K Regulation. Notably, the amendment in item 101, which requires disclosure on general development of a business, reduces the disclosure of information from an exclusive list of 12 topics to a non-exclusive list of seven topics, giving registrant’s discretion in determining material developments without adhering to strict standards. Similarly, item 102 provides for a quantifiable threshold for registrants to disclose pending legal proceedings, particularly, it requires disclosure of environmental proceedings with potential monetary sanctions of $300,000 or above. But such thresholds are specific to individual disclosure items and does not concern general standards for determination of ‘materiality’. Furthermore, the amendment allows registrants the flexibility to opt for an alternative threshold, which is deemed reasonably effective, for disclosing material environmental proceedings, capped to the lower of $1 million or 1% of the registrant’s present assets. In this way, SEC, via abovementioned amendments, has removed prescriptive or qualifying standards and empowered registrants to exercise discretion to determine ‘material developments’ for the disclosure purposes.
Meanwhile, pursuant to the LODR amendment of June 2023, the guidelines for determination of materiality in relation to disclosure of events/information have been revised to include an incremental quantitative threshold. In contrast to the approach being followed by the SEC, SEBI’s approach appears to be moving towards more ‘prescriptive-based’ approach for the determination of materiality. This is because, rather than event specific, the amendment applies universal thresholds for all types of disclosures under discretionary material bucket and has also increased the numbers of events under deemed materiality basket.
In particular, the inclusion of Clause 20 under the deemed material bucket pursuant to the LODR amendment has imposed an obligation upon listed entities to disclose details regarding certain legal/regulatory proceedings without any materiality qualifier or other thresholds. This is in contrast to USA’s regime which provides flexibility to the registrant in determining material legal proceeding (as discussed above). Another notable instance is amendment to Clause 5A, which has introduced an additional obligation on listed entities to disclose information regarding certain agreements that affect the management or controlling power of the listed entity or impose any restriction or liability upon it. This amendment is inclusive of the agreements, wherein, listed entity is not directly involved; therefore consequently, stakeholders except for listed entity are also bound by these disclosure obligations. However, US regime does not necessarily mandate disclosure of every such arrangement, meaning thereby, the disclosure obligations only concern listed entity and do not extend to other stakeholders, as seen in India.
Based on the above analysis, it can be asserted that the Indian regulatory framework post June2023 amendment shifted towards a prescriptive-based disclosure model, in contrast to the SEC, which is moving towards a principle-based approach. It is pertinent to note that the principle-based approach provides greater freedom to issuers in identifying material information for disclosure based on their unique business models, thereby serving the interests of investors. Conversely, a prescriptive-based approach may result in information overload, negatively impacting investors. Therefore, the objective of facilitating informed decision-making cannot be achieved, if due to overwhelming amount of data, investors fail to scrutinize material information.
MATERIAL PRICE MOVEMENT: PRESCRIPTIVE OR PRINCIPAL BASED?
The proposed consultation paper seeks to shift existing paradigm from the current materiality event requirement to a criterion focused on material price movement for verifying market rumors in mainstream media. Thereby, the key question, herein, is whether this proposed amendment is prescriptive or principle-based. Under the existing regulation, disclosure of market rumours is mandatory if they are related to an event regulated by Regulation 30. However, this approach might overwhelm investors due to sheer volume of mainstream media outlets, with roughly 1,40,000 registered publications and approximately 400 news channels in India.
Therefore, in order to streamline the flow of information, the proposed suggestion seeks to narrow down the verification of market rumors to instances wherein the rumors might cause a material price movement in the relevant share’s scrips. Critics may argue that various factors contribute to share price movements, such as public relation or government policies. However, the consultation paper has clarified that only price movements attributable to market rumors would necessitate verification. It can be argued that the proposed amendment would impose higher burden on listed entity as the entities have to keep a simultaneous track of market rumor and movement in share price of scrips. Nonetheless, this move would advance the interest of investors, and it hints on principal nature of the proposed amendment. Lastly, it is also in tune with the advance security law jurisprudence of USA wherein a listed company promptly needs to dispel unfounded rumours which result in unusual market activity or price variations.
CONCLUSION AND SUGGESTION
Moving forward with the above discussion, it seems reasonable to assert that any information having potential to significantly influence decision-making power of investors, shall be deemed material. Consequently, it can be concluded that principle-based approach is more in tune with the concept of materiality because it grantsgreater autonomy to the listed entities to decide for themselves ‘what is material and how shall it be disclosed to general public’. This approach is more aligned with the entity’s management and will better assist investors in tracking the decision-making status of the registrant. However, the June 2023 amendment to LODR is more so inclined towards prescriptive based approach.Nonetheless, the consultation paper released by SEBI alignswith principle-based approach, as seen above. It may be contended that the proposed changes in the consultation paper may substantially augment compliance burden for the registrants, and might hamper with smooth disclosure of information. But at the same time, it streamlines the information overflow for the investors and thereby, helps investors to make sound and informed decision.
(This article has been co-authored by Rituraj Singh Parmar and Devyani Mishra, students at National Law Institute University, Bhopal)
CITE AS: Rituraj Singh Parmar and Devyani Mishra, ‘Shifting Paradigm Of Materiality Regulations: From Prescriptive To Principle Based’(The Contemporary Law Forum, 26 March 2024) <https://tclf.in/2024/03/26/shifting-paradigm-of-materiality-regulations-from-prescriptive-to-principle-based/> date of access.