SEBI: Proposal on Integrated Disclosures

An aspect of the Indian securities regulations that has always been somewhat puzzling is the stark disparity in the disclosure regimes governing the primary markets and secondary markets. While a strong disclosure regime has been a boon to the primary markets where companies making a public offering are required to issue a prospectus with fairly onerous disclosure requirements accompanied by stiff liability provisions, an equally weak disclosure regime in the secondary markets has been a malaise in the secondary markets which function with far less continuing disclosure obligations on companies that are already listed on the stock exchanges. As an earlier post on this blog had noted:

“In the Indian context, the SEBI (Disclosure and Investor Protection) Guidelines, 2000 that have been strengthened over the years, impose strict disclosure norms on companies issuing capital to investors. However, this is applicable only when companies make public offerings (an initial public offering (IPO) or a follow-on public offering (FPO)) or qualified institutional placements (QIP) of shares to investors; these are typically known as primary market transactions. But, once the shares of the company are already traded on the stock exchange, the obligations of companies to make disclosure are much less severe. Hence, a person who buys shares of a listed company on the stock exchange in a secondary market transaction has far less information compared to a person who purchases shares in a public offering. This causes many retail secondary market investors to acquire shares in overvalued stocks during a boom without having understood the fundamentals of the company and the economy. This disparity between disclosures in primary market transactions and secondary market transactions may require correction by SEBI.”

As to the sources of law governing disclosures, primary market transactions (offerings by companies or selling shareholders) are governed by the SEBI (Disclosure and Investor Protection) Guidelines, 2000, which are fairly detailed, while secondary market disclosures (or continuing disclosures by existing listed companies) are governed by the listing agreement with the stock exchanges (clause 41 and other related provisions) which require far less disclosures on a continuing basis (and these too are mainly related to financial reporting).

As a measure to address this problem, SEBI yesterday announced that the Sub-Committee on Integrated Disclosures has submitted its report for standardizing and streamlining the corporate disclosures by integrating initial disclosures made under an offer document with the continuing disclosure requirements after a company gets listed. The report states:

“The goal of reduction of duplication and a holistic approach to disclosures can come about only when we are able to move from registration of issue of securities to a model where the company itself is registered. Under the proposed structure, there will be a need to strengthen the existing disclosure norms so that information which is sought only at the time of issue of capital becomes generally available not only to investors of new securities but to the existing shareholders as well. As a result, full disclosures would be enjoyed by a larger class of investors and potential investors; at the same time, by avoiding duplication, issue costs would come down. Seasoned companies with a reliable track record would be able to raise capital easily and at a lower cost.”

For those of you who are interested in the modalities for integrated disclosures, these are extracted below from the Report:

“A major benefit of the proposed fungibility between initial disclosures (prospectus) and continuous disclosures (various disclosures like the annual report, quarterly reports, stock exchange notifications etc.) would be the reduced cost of compliance. Thus, if a company goes to the capital market for the first time in an IPO, it would find that because of the fungibility of company information, the cost and effort in continuing disclosures and in creating an annual report would get reduced drastically. Conversely, a seasoned listed company (which is listed for over 1 year and is in compliance with the various relevant enactments) already has the company information out in the public domain and thus could merely copy and paste the information along with any material updates and transaction based information, whenever it is required to prepare an offer document. An even more efficient means of integrating the information would be to incorporate the company information by reference into a prospectus. Such incorporation by reference exists in the US markets. Of course, any updates since the last annual/quarterly reports must be published as material updates in the prospectus along with the transaction based information about the securities on offer. Further, the integration will not dilute the liability of the issuer, directors, merchant bankers and others who must continue to carry out necessary due diligence before raising of capital by the company. Thus integration could reduce the cost of compliance while at the same time improve the disclosures being made to the investors.

Even without incorporation by reference, there will be two benefits of the above exercise. One, the same set of information and the same format will be used for making public company information whether it is the primary market disclosures or the secondary market disclosures. Conversely, even if a company is a first time issuer of equity capital, its continuous disclosures would be cast in the same die as the company information in the prospectus (as described in the previous paragraph) – thus making disclosures transferable and fungible. Second, continuous information will be substantially strengthened, eliminating the bias the current regulatory framework has towards protecting primary market investors over protecting secondary market investors. An efficient means of integrating could be by using a single set of regulations which gives a descriptive line item of company information. For instance there would be line items of: Description of Business, Description of Property, Legal Proceedings, Financial Data, MD&A (company information), Contents of First Page of Prospectus, Types of Securities Offered, Disclosure of Selling Commissions (transaction information). This master set of regulations can then be used with different forms. For instance, to draft a prospectus, one would use Company information and transaction information from the various line items. Similarly for a rights issue a simpler set of line items would be used from the same pool of items. A listed company which is coming to tap further capital thus can incorporate by reference the company information and use only the transaction information in its prospectus. For an annual report, one would tap the same pool and take only the company based information.”

This essentially introduces a master set of disclosure regulations from which companies can adapt and choose specific line items depending on the nature of disclosure required, e.g. for a initial public offering, rights issue, follow-on public offering or even annual or other continuing disclosure. Further, companies have the option of incorporating by reference other information (such as annual report or other financial statements) into offer documents.

This streamlining of disclosures was long overdue and will go a long way in integrating the primary and secondary markets. This is consistent with the U.S. SEC requirements that provide for a master set of disclosures in the form of Regulation S-K (for non-financial information) and Regulation S-X (for financial information) from which companies are required to borrow specific line items depending on the nature of disclosure required to be made. It would also make newer types of issuances (such as shelf-registration and fast-track offerings) more meaningful, for where companies have already made adequate continuing disclosures, this scheme would largely cut down the disclosure to be made at the time of shelf-offerings or fast-track public offerings.

Comments are due on the Report and the draft disclosure requirements by March 15, 2008.

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

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