[Shantanu Dhingra is a 3rd year law student at the National Law University Odisha]
The Securities and Exchange Board of India (SEBI) on 20 February 2023 released a consultation paper focused on streamlining disclosures by listed entities, intending to strengthen compliance with the SEBI Listing Obligations and Disclosure Requirements Regulations, 2015. Central to this post is the notion of materiality, which plays a crucial role in determining the nature and scope of information that listed entities must disclose to the market and investors.
This post explores the legal complexities surrounding materiality in SEBI’s consultation paper and provides insights into refining the material event determination process. Through a critical analysis of relevant case law and a comparative study of international practices, this post aims to present innovative legal approaches and best practices that can inform India’s materiality determination process.
Dissecting SEBI’s Materiality Framework
The SEBI consultation paper proposes a materiality framework that encompasses both quantitative and qualitative factors, aiming to provide clearer guidance for listed entities in determining material events for disclosure. The proposed framework delineates criteria such as financial implications, strategic consequences, and reputational risks, which together form the basis for assessing materiality.
However, the framework also introduces interpretative ambiguities and divergent applications, potentially leading to inconsistencies in disclosure practices across the industry. A primary challenge within the proposed framework is the absence of a clear threshold demarcating financial materiality. The lack of explicit guidance can result in subjectivity and discretion in evaluating an event’s significance. For instance, the Satyam Computer Services accounting scandaldemonstrates the implications of ambiguous financial materiality guidelines, as insufficient disclosures led to a significant erosion of investor confidence and market integrity.
Furthermore, qualitative factors such as strategic importance and reputational risks are inherently subjective and may pose challenges in quantification. This subjectivity frequently results in divergent interpretations of materiality. The Kingfisher Airlines crisis serves as a case in point, where inadequate disclosures about the company’s financial health and strategic decisions contributed to substantial losses for investors.
In addition to the challenges posed by the proposed framework, relevant case law provides valuable insights for refining the materiality determination process. The Infosys whistleblower case underscores the importance of clearly defining materiality, as the lack of timely and transparent disclosures related to the allegations resulted in significant stock price fluctuations and reputational damage. This case emphasizes the need for a well-defined materiality framework that considers both financial and non-financial factors.
Similarly, the Tata-Mistry dispute highlights the importance of incorporating qualitative factors such as corporate governance and stakeholder relations into the materiality determination process. Inadequate disclosures regarding corporate governance issues in this case led to concerns over transparency and raised questions about the company’s commitment to shareholder interests.
In conclusion, examining the challenges and relevant case law relating to SEBI’s proposed materiality framework provides valuable insights for refining the framework to address ambiguities and inconsistencies in disclosure practices. By incorporating both quantitative and qualitative factors and learnings from past experience, the materiality framework can be improved to better protect investor interests and maintain market integrity.
Gleaning Insights from Global Materiality Practices
The US model, with its “total mix of information” standard, places significant weight on the reasonable investor’s perspective. This approach has merit in terms of ensuring that materiality is assessed from the viewpoint of the intended audience, i.e., the investor. However, it may not fully capture the complexity of an ever-evolving market landscape, especially in terms of non-financial factors such as ESG considerations. To address this limitation, the Indian context could benefit from incorporating an adaptable framework that considers both financial and non-financial factors in materiality determination.
On the other hand, the EU’s principles-based approach provides flexibility to adapt to changing market conditions but may suffer from ambiguities and inconsistencies in its application. To mitigate this drawback, SEBI could explore establishing clearer guidance or minimum standards that listed entities must adhere to while maintaining the flexibility offered by the principles-based approach.
In synthesizing insights from the US and EU models, it is crucial to create a hybrid approach that is well-suited to the Indian market’s unique characteristics. This tailored approach should blend the strengths of both models, incorporating the reasonable investor perspective and the principles-based approach, while addressing their respective limitations. Such an approach would help develop a more robust and effective material event determination process that resonates with the central argument of the post.
Furthermore, it is essential to emphasize the importance of learning from global best practices and adapting them to the Indian context, rather than merely replicating them. By critically analyzing and understanding the underlying rationale of these practices, SEBI can create a materiality framework that not only aligns with international standards but also addresses the specific challenges faced by the Indian market.
In conclusion, deepening the analysis of global materiality practices and maintaining a professional tone allows us to better address the central argument of the post. By examining the US and EU models, identifying their strengths and weaknesses, and proposing a tailored approach for the Indian context, we contribute to the ongoing discourse on refining the material event determination process to balance transparency, corporate interests, and investor protection.
Rethinking Materiality: A Normative Proposal
To address the challenges in SEBI’s proposed materiality framework and provide a more in-depth critical analysis, the following recommendations suggest creative legal arguments and solutions that surpass the existing framework and SEBI’s suggestions in its consultation paper. Relevant case law has been incorporated to demonstrate the potential benefits of these recommendations.
1. Adopting a dual-threshold approach for financial materiality: SEBI should consider a dual-threshold approach, wherein both absolute and relative thresholds are used to determine financial materiality. This approach could include a percentage of a listed entity’s total assets, revenues, or market capitalization, as illustrated in the US SEC’s Regulations S-K. Additionally, it could include an absolute threshold, such as a specific monetary value, to ensure that even smaller events with significant financial implications are captured. This dual-threshold approach would reduce ambiguity and subjectivity in materiality determination, leading to a more consistent application across various sectors and listed entities. For instance, a company experiencing a substantial drop in revenues due to supply chain disruptions might trigger the relative threshold. Simultaneously, a smaller company suffering a significant loss due to a single event, such as a legal settlement, might trigger the absolute threshold. A potential challenge to this approach is the difficulty in determining the appropriate thresholds for various sectors and company sizes. SEBI could address this by engaging in extensive consultations with market participants and analyzing industry-specific data to establish suitable thresholds. In the Satyam Computer Services accounting scandal, a dual-threshold approach might have prompted earlier and more transparent disclosures, potentially averting the erosion of investor confidence and market integrity.
2. Introducing a risk-based tiered materiality disclosure system: SEBI could implement a risk-based tiered materiality disclosure system, inspired by the EU’s Market Abuse Regulation (MAR). This system would consider the potential risk posed by material events to investors and the market as a whole, triggering different reporting obligations based on the assessed risk level. This approach would help prioritize disclosures, ensuring that the most crucial information reaches investors without overwhelming them with excessive details. In the Kingfisher Airlines crisis, a risk-based tiered disclosure system might have led to more accurate and timely disclosures of the company’s financial health and strategic decisions, potentially minimizing investor losses.
3. Integrating qualitative factors and ESG considerations: SEBI should incorporate qualitative factors and ESG considerations into the materiality assessment process. This comprehensive approach would involve assessing the potential impact of an event on a company’s reputation, relationships with stakeholders, strategic direction, and sustainability performance. This integration would capture the multifaceted nature of materiality, ensuring that all relevant factors are considered and that disclosures align with global trends in investor priorities. The Tata-Mistry dispute highlights the importance of incorporating qualitative factors such as corporate governance and stakeholder relations, as inadequate disclosures regarding these issues raised concerns over transparency and the company’s commitment to shareholder interests.
4. Developing a principles-based materiality assessment framework: SEBI could benefit from a principles-based framework that provides guidance on materiality assessment while allowing for adaptability to evolving market conditions and specific circumstances. This framework should emphasize transparency, accountability, and stakeholder engagement, promoting a disclosure culture that focuses on the quality and relevance of information provided to investors. The Infosys whistleblower case underscores the importance of a principles-based framework that considers both financial and non-financial factors, as the lack of timely and transparent disclosures related to the allegations resulted in significant stock price fluctuations and reputational damage.
5. Fostering cross-border regulatory collaboration: Finally, SEBI could explore opportunities for collaboration with other regulatory bodies, both domestic and international, to develop a harmonized approach to materiality determination. Drawing lessons from the International Organization of Securities Commissions (IOSCO) and its principles on disclosure, this would not only enhance consistency across jurisdictions but also facilitate cross-border cooperation in addressing emerging legal challenges in the disclosure landscape. By adopting a collaborative and informed approach, SEBI can foster a robust and effective materiality framework that balances transparency, corporate interests, and investor protection.
In conclusion, this post has examined the complexities surrounding materiality in SEBI’s consultation paper and provided insights and recommendations for refining the material event determination process. By learning from relevant case law and international best practices, and incorporating innovative legal solutions such as a dual-threshold approach, risk-based tiered disclosure system, qualitative factors integration, and fostering cross-border regulatory collaboration, SEBI can create a more robust and effective materiality framework. Addressing the materiality conundrum is vital to strike the right balance between transparency, corporate interests, and investor protection, ultimately contributing to a more transparent, accountable, and resilient financial market in India.
– Shantanu Dhingra