SAT Rules on “Materiality” of Disclosures

A somewhat peculiar fact situation arose for consideration of the Securities Appellate Tribunal (SAT) in Electrosteels Limited v. Securities and Exchange Board of India (order dated 14 November 2019). Electrosteel Limited (ESL) embarked upon an initial public offering (IPO) in 2010. ESL’s parent is Electrosteel Castings Limited (ECL), a public listed company. Since iron ore is an essential raw material for the manufacturing processes of both companies, ECL made applications to various governmental authorities for obtaining iron ore mining blocks in the Kodalibad Reserve Forest, West Singhbhum District, Jharkhand State. The limited point is that while an Expert Appraisal Committee of the Ministry of Environment and Forests (MoEF) recommended the project application, in late 2008 the Forest Advisory Committee (FAC) “rejected the proposal on account of being part of core zone of Singhbhum Elephant Reserve and critical to wildlife conservation”. The MoEF conveyed this rejection on 16 January 2009 to ECL. However, on 10 July 2009, the Jharkhand Government requested the MoEF to reconsider the matter. It was at this juncture that ESL undertook and completed its IPO during the period between March 2010 and September 2010. Curiously though, several months after the conclusion of the IPO, the MoEF approved the diversion of forest land.

The oddity of the situation is that at the time of the IPO there was a rejection of ECL’s application with a request to reconsideration. In other words, no approval was in existence. The approval came in only after the IPO was complete. Hence, the substantive legal question before the SAT was whether the rejection of ECL’s application for forest clearance, as it stood at the time of the IPO, had to be disclosed to the prospective investors of ESL and to the shareholders of ECL. The responsibility for disclosures arises on three entities. First, ESL has the responsibility to make disclosures in its offer document while undertaking the IPO. This is governed by the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009. Second, ECL, which is an existing listed company, bears the obligation to make continuous disclosures of material matters in terms of clause 36 of the listing agreement. Third, the intermediaries in the form of the investment banks in ESL’s IPO carry due diligence obligations to ensure the accuracy and completeness of the disclosures. In an earlier order passed on 31 March 2016, an adjudicating officer of the Securities and Exchange Board of India (SEBI) found all three parties above guilty of violation for non-disclosure of the rejection letters from the MoEF and imposed a penalty of Rs. 1 crore on ESL, Rs. 1 crore collectively on three investment banks, and Rs. 50 lakhs on ECL. It is against this order that the affected parties preferred an appeal before the SAT.

In its ruling, the SAT concurred with the strict approach adopted by SEBI’s adjudicating officer. It noted:

16. … Therefore, the letter and spirit (as well as absence of pictures) of the disclosure requirement is the need for disclosing all material events in clear terms with very little discretion for judging the degree of materiality. The emphasis is on disclosure; not otherwise, which means disclose even when the issuer doubts whether there is any materiality. In other words, it would imply that only facts/ events which the issuer is undoubtedly sure of having no relevance to the issuer or to the issue can be excluded from disclosure.

17. The required permissions for the mining project is an important component of the statutory approvals. The project itself is critical for ESL as iron ore at competitive rates and in required quantity would be available seamlessly only from this project and hence the MoU with ECL, the parent company, for assured, uninterrupted supply from the mining project for 20 years. …

Accordingly, the SAT came to the conclusion that the rejection by the FAC of the forest clearance was material information, and that the companies’ failure to disclose the same led to the violation of the relevant SEBI regulations and the listing agreement. In doing so, the SAT has adopted a strict interpretation of the “materiality” requirement. It leaves no discretion to the parties to determine whether the information is relevant to the investors. The SAT’s approach focuses on the requirement of greater disclosure, effectively suggesting that if one is in doubt, disclosure is the only option.

In the present case, the fact that the MoEF subsequently granted the approval did not come to the rescue of the parties involved. This was considered to be a matter of hindsight, and what was relevant is that the position at the time of the IPO involved the rejection, although it was accompanied by the companies’ request for reconsideration of the same. While the emphasis on disclosure is understandable, this ruling from SAT suggests that it is unwilling to condone even technical violations even when they may not have in fact caused any loss to investors. The only consolation for the affected parties is that the SAT reduced the penalty imposed on ESL and the investment banks (collectively) from Rs. 1 crore to Rs. 50 lakhs, but retained the penalty of Rs. 50 lakhs imposed on ECL. The rather technical nature of the violation became relevant only for determination of the penalty and not on the substantive question of materiality.

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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