SEBI’s Measures for Enhancing Corporate Transparency through disclosures

February 15, 2024

SEBI’s Measures for Enhancing Corporate Transparency through disclosures

This article has been written by Mr. Tejas Chandna, a Third year student of Symbiosis Law School, Pune

Introduction

With its multiple circulars in 2023, the Securities and Exchange Board of India (SEBI) introduced regulatory amendments and proposals, particularly focusing on materiality thresholds, Real Estate Investment Trusts (REITs), Infrastructure Investment Trusts (InvITs) regulations and Foreign Portfolio Investments (FPIs). Firstly, this article argues some significant effects on management and company’s efficiency after granting nomination rights to unitholders with a specific unit ownership percentage. Secondly, it analyzes how non-compliance of SEBI’s Listing Obligations and Disclosure Requirements (LODR) Regulations for listed entities to disclose material events/information, categorized under Para A and Para B of Schedule III, ensures compliance without diluting disclosure requirements.

Certain Foreign Portfolio Investors (FPIs) exhibit concentrated investments in single corporate groups, raising concerns of potential circumvention of regulatory requirements. The Government of India issued Press Note 3 in April 2020 to mitigate risks of opportunistic takeovers, focused on entities from border-sharing countries. Identification of Beneficial Owners (BOs) of FPIs poses challenges, as economic interests may be dispersed across multiple entities, complicating regulatory oversight. In its third segment, the article lists ambiguity with amended SEBI (Foreign Portfolio Investors) Regulations, 2019 and exemptions for certain categories of FPIs, underscoring the need for clarity and compliance within the regulatory framework.

Nomination Rights to Unitholders leading to managerial Risks

The SEBI (Real Estate Investment Trusts) Regulations, 2014 (“REIT Regulations”) and SEBI (Infrastructure Investment Trusts) Regulations, 2014 (“InvIT Regulations”) were enacted on September 26, 2014, establishing the regulatory framework for REITs/InvITs. While the REIT Regulations exclusively envision publicly offered listed REITs, the InvIT Regulations allow for two structures:

1) Publicly offered and listed, and

2) Privately placed and listed InvITs.

Both REITs and InvITs were introduced to offer investors exposure to real estate and infrastructure projects, promoting risk diversification through pooling arrangements. Despite regulations stipulating equal rights for all unitholders, certain REITs/InvITs have granted or proposed special rights, such as board nomination rights, to investors holding a specific percentage of units. This deviation from regulatory norms prompts the need for public comments to assess the feasibility and suitability of such differential rights, especially concerning unitholders’ nomination of directors on the board of Manager/Investment Manager or the Unitholders Council.

Under Regulations 4(2)(g) of the SEBI (REITs) Regulations, 2014, no unit holder of the REIT enjoys voting rights over another unit holder, which by inference also includes InvITs. In May 20231, SEBI released a consultation paper, where it had proposed a provision granting nomination rights to unitholders who hold a specific percentage of units or more, allowing them to appoint directors to the board of the Manager/Investment Manager.

Notably, this meant that the unitholder with a minimum of 10% of units will have the privilege of nominating one director for every 10% of units held, thus allowing him to serve on the board of the REIT/InvIT’s Manager/Investment Manager. This step, to ensure transparency leads SEBI in also allowing flexibility in meeting this minimum requirement. By this, unitholders with less than 10% individual ownership can now pool their units together to meet the threshold collectively.2

Now, looking at managerial risks, this can lead to the formation of an excessively large board. Now, it can result in inefficient meetings. Subsequently, leading to lack of engagement from all directors and participation with diverse voices.

Introduction of materiality thresholds for disclosure of material events

In a landmark step by SEBI3, SEBI (Listing Obligations and Disclosure Requirements) Regulations (SEBI LODR) mandated listed entities to disclose three categories of events/information. Firstly, events and information considered material under Para A, Part A of Schedule III of SEBI Regulations. Secondly, events and information falling under Para B, Schedule III, which meet the materiality threshold outlined in Regulation 30(4) of the SEBI Regulations. Thirdly, voluntary disclosures of events deemed material by the Board of Directors. Furthermore, the Amendment necessitates companies to adjust their materiality policy to align with the regulation’s principles without compromising any requirements stipulated in the new regulations. Now, the regulatory pattern can be seen in need of confirmation especially from Entry 19 and 20 of Schedule III of the regulations.

According to Schedule III of the regulations, Entries 19 and 20 outline regulatory actions that listed companies must disclose, regardless of their material significance. Both entries encompass actions by regulatory, statutory, enforcement, and judicial bodies against the listed entity, its directors, KMPs, promoter, subsidiary, and senior management in relation to the listed entity.

Entry 19 of Schedule III necessitates disclosure of the initiation of certain actions such as search and seizure, investigations under the Companies Act, 2013, and reopening of accounts under the same Act. In contrast, Entry 20 requires disclosure of actions taken and orders passed regarding events like suspension, imposition of fines or penalties, closure of operations, and other significant impairments. Entry 20 also includes the term “any other similar action,” thereby broadening the scope of disclosures.

The main difference between the two provisions lies in the timing of disclosure. While disclosure for events like search and seizure is required at the initiation stage, disclosure for events like imposition of penalties is mandated only after the action has been taken or the order has been passed.

Despite outlining events for disclosure regardless of their materiality, Entries 19 and 20 leave room for ambiguity regarding the scope and extent of regulatory actions to be disclosed. For instance, there is uncertainty about the level of fines and penalties that should be disclosed, leading to practical challenges for companies as they may find it impractical to disclose every minor fine or penalty. Similarly, the interpretation of the term “any other similar action” needs clarification to determine its applicability, especially considering that the other events listed under Entry 20 relate to disclosures of serious disruptions to business operations.

There is a concern regarding maintaining the privacy of companies and allowing businesses to maintain internal control over their operations without the necessity of disclosing every strategic move they make. For example, while the verification of rumors is aimed at benefiting investors, it may have negative consequences on sensitive strategic partnerships or attempts to gain a first-mover advantage in the business’s privacy. However, failure to disclose information can result in significant penalties, such as fines of up to one lakh rupees per day for delays or one crore rupees, whichever is lower, as stipulated in Section 23-A of the Securities Contracts (Regulation) Act, 1956, and Section 15-A(b) of the SEBI Act, 1992.

Therefore, it is crucial to exercise caution when interpreting the disclosure requirements under SEBI LODR. Efforts should be made to establish consistent practices and standard perspectives across industries regarding disclosures. This can be achieved by considering all relevant laws applicable to a particular event during the interpretation process. Not only will this ensure consistency, but it will also guarantee the appropriate level of disclosure by a company, striking a balance between investors’ interests and statutory compliance requirements.

Mandatory Foreign Portfolio Investments (FPI) disclosure

In new developments through circulars in 20234, FPIs are targeted SEBI, if they have over 50% of their assets under management (AUM) invested in the equity of a single Indian corporate group. Additionally, FPIs are flagged if their equity AUM in Indian markets surpasses INR 25,000 crore, either individually or as part of an investor group. These criteria are deemed reasonable as they focus on FPIs with substantial exposure to Indian corporate groups or significant investments in the Indian market. By 22(6) and 22(7) of the FPI Regulations, SEBI circulated them in detailed Standing Operating Procedure (SOP), which details a mechanism for conditions and exemptions, with the circular having failed to define “single Indian corporate group”.

With its advantage, SEBI intends to foster transparency by selecting FPIs with concentrated positions, which can impact market stability. However, exemptions are provided for certain categories of FPIs. For instance, exemptions are granted to FPIs whose holdings in an Indian corporate group amount to less than 25% of their overall global AUM at a scheme level, as well as those whose equity AUM in Indian markets is below 50% of their overall global AUM at a scheme level. Furthermore, exemptions are extended to FPIs unable to liquidate excess holdings due to statutory constraints, such as lock-in restrictions typically imposed on anchor investors. In such cases, FPIs seeking exemption must satisfy their Designated Depository Participant (DDP) about their eligibility, thereby adding to the compliance burden associated with investing in Indian securities markets.

Conclusion

Under section 11B of the said Act, SEBI has the power to issue directions in the interest of investors or orderly development of securities market or to prevent the affairs of any intermediary or other persons connected with the securities market being conducted in a manner detrimental to the interest of investors or securities market. Though, in Shankar vs SEBI7, the court pointed that section 11 of the SEBI Act, is to protect the interests of investors in securities. to promote the development of and to regulate the securities market. By such assumption, SEBI can take such measures “as it thinks fit”, however the above regulatory provisions need more clarification to prove the intention of its parent act.

In conclusion, it signifies a pivotal shift towards ensuring transparency, accountability, and investor protection within India’s financial landscape. The amendments and proposals targeting REITs, InvITs, and FPIs underscore SEBI’s commitment to fostering a conducive environment for both domestic and foreign investors while mitigating systemic risks. However, the challenges of balancing disclosure requirements with privacy concerns and the need for clarity in regulatory frameworks persist, necessitate ongoing dialogue and refinement to uphold market integrity and stability. As India’s capital markets continue to evolve, SEBI’s role as a vigilant regulator remains paramount in safeguarding the interests of all stakeholders and sustaining investor confidence in the country’s economic trajectory.

References

SEBI Circulars and Consultation Papers

Articles

This article was originally written by Asish Philip Abraham, Astha Sinha and Simran Chetwan published on SCC Online website. The link for the same is herein: https://www.scconline.com/blog/post/2024/01/17/operational-challenges-for-disclosures-under-revised-regime-of-sebi-lodr/
This article was originally written by Arka Mookerjee , Pracheta Bhattacharya , Sourav Modi and Rishika Kharbanda published on Mondaq website. The link for the same is herein: https://www.mondaq.com/india/fund-management-reits/1323666/special-rights-to-unitholders–role-of-sponsor-in-reits-and-invits#:~:text=SEBI%20proposed%20that%20any%20unitholder,manager%20of%20the%20REIT%2FInvIT.

Cases

Shankar Sharma v. Securities and Exchange Board of India (SEBI), 2008 SCC OnLine CIC 3294

February 15, 2024