A material mistake by Sebi

Newly coded listing regulations make disclosure of acquisition by a listed company mandatory

The terms on which companies get listed on Indian stock exchanges just got codified into regulations. The Securities and Exchange Board of India ( Sebi) has notified the Securities and Exchange Board of India ( Listing obligations and disclosure requirements) Regulations, 2015, ( Listing Regulations). They will take effect on December 1, 2015.

For far too long, the terms of listing have been governed by an unhelpful legal construct —the listing agreement, an agreement between the stock exchange and the listed company.

Typically, an agreement is “private law” and governs only the parties to the agreement. However, the listing agreement has been wrongly treated like an instrument of “ public law” that would bind the world at large. One did not even need to sign it — it was modified at will by an agency that was not even a party to the agreement, viz Sebi.

Fortuitously, this legally infirm policy belief never came up for serious challenge except in the Mallya- Chhabria takeover dispute over Herbertsons ( there, the issue was that the listing agreement had a provision that shareholders who buy more than five per cent shares should report it and the acquirer in that case argued that an agreement that he was not party to, could not bind him). That dispute got settled without the law truly getting tested.

Sebi has now reproduced the provisions of the listing agreement in the Listing Regulations — which would now legally govern the world at large — not just listed companies and stock exchanges, but also the regulator.

While a large part of the exercise has been to consolidate the provisions, there is one area of new policy which is retrograde and lays the ground for adverse regulatory outcomes, no matter how well- intentioned it may be. The Listing Regulations, now mandate that any and every acquisition including an agreement to acquire would need to be disclosed by a listed company without applying any test of materiality for the disclosure. The term “ acquisition” has been defined as acquisition of control or acquisition of five per cent of shares or voting rights by the listed company in any other company. Absence of materiality would mean that regardless of the scale and size of the listed company, acquisition of any tiny company would need to be disclosed. This is a new measure. So far, listing agreement has only required disclosure of pricesensitive information, which by definition, would be information that could have an impact on the price of the securities in the market.

For example, a company with a net worth of Rs.1,000 crores would need to report purchase of shares of 5 per cent or more in another company, or purchase of control over another company, even if the value of the other company were just Rs.10 crores. Often, residential apartments are bought by way of buying companies that own them. Now, if one were to buy the company that owns the apartment it would require a public disclosure under this new requirement, while if one were to buy just the apartment there may be no requirement to make a public disclosure. This is because the absence of materiality is an element stipulated only for acquisition of companies and not for other assets. The special definition for the term “ acquisition” to cover acquisition of companies and not other types of business organisations, is inexplicable. Therefore, if one were to buy a bunch of assets, or, if one were to acquire a stake in a limited liability partnership, one would need to make a disclosure to the public only if the deal were material. But once it is a company that is being bought, materiality would be given the go- by.

The removal of materiality as a relevant factor is a step backwards. Offer documents in the Indian securities markets are extraordinarily bulky and contain a lot of irrelevant information, primarily because in a number of areas, disclosures are not truly linked to materiality. In other words, our regulatory framework requires issuers of securities to err on the side of excessive disclosures, which drowns out what is really necessary ( read material) for taking an informed decision.

All pointers to reform of the primary market have been pushing for making offer documents meaningful by cutting out unnecessary, irrelevant and noisy non- material content. Even in the regulations governing insider trading, typical types of price- sensitive information are listed to create only rebuttable presumptions of their being price- sensitive — the contrary may be established.

There is another reason why Listing Regulations positively making materiality irrelevant is a step backwards. It would create fertile ground to mislead investors in the market with noisy, irrelevant and nonmaterial disclosures. Investors would think that such nonmaterial information is indeed material, since the law requires it to be published in the public domain. Such an approach would militate against another regulatory objective of Sebi, which has had occasion to chase listed companies for falsely talking up the share price by making disclosures of non- material acquisitions, leading the market to believe that things are positive.

Now, the defence would be to just point to the new law to say that the surfeit of irrelevant disclosures is in fact a regulatory mandate. At times, the quest to achieve the utopian “best” can easily turn out to be enemy of the “ good”.

Business Standard, New Delhi, 21st Sept. 2015