Disclosure and due diligence obligations in India are evolving, say Varoon Chandra and Lionel D’Almeida
The Securities and Exchange Board of India (SEBI) is the primary regulator of equity and debt offerings by Indian companies. As is the case with other jurisdictions, the prescribed disclosures with respect to such capital issuances are intended to ensure adequate and timely disclosure, so as to enable investors to make balanced and informed investment decisions.
Typically, securities regulators approach this role in one of two ways. Some regulators prescribe a broad set of disclosure guidelines and leave the onus of compliance on the issuer and other intermediaries (primarily the investment banks). This is subject to the overarching requirement that all material information that would impact an investor’s investment decision requires disclosure. The second approach is to have more prescriptive regulations, which outline specific disclosure requirements with limited discretion vis-à-vis disclosures available to the issuer and intermediaries.
SEBI has historically adopted a combination of the above approaches. However, with respect to prescribed detailed disclosure requirements, latent ambiguities in the regulations have resulted in issuers and investment banks needing to exercise a degree of discretion. Further, certain disclosure requirements prescribed in offer documents may not necessarily have a bearing on the capital issuance at hand or the issuer company. For instance, tracing the share capital build-up from the inception of an issuer, as required to be disclosed under the ICDR Regulations, is a task that is time consuming, and at times infructuous (for companies in existence for significant periods of time) due to unavailability of records. In the absence of any adverse due diligence findings (which would in any case have been required to be disclosed if they were material), such disclosures serve little purpose for an investor.
SEBI imposes significant obligations on market intermediaries, specifically merchant bankers, to conduct due diligence on issuers and ensure compliance with relevant disclosure norms and SEBI periodically inspects merchant bankers in order to review their processes, and to seek evidence of due diligence exercised. For instance, SEBI’s inspectors routinely seek documentary evidence of educational qualifications of independent directors of an issuer. This may not always be available and can be an expensive exercise which may not always secure the interests of the investors.
SEBI has sought to reduce disclosure with respect to litigation as well as creditors in offer documents for public issues by moving to a materiality-based approach. Similarly, it has also rationalized disclosures with respect to tax litigation and outstanding creditors.
However, SEBI has simultaneously broadened its definition of group companies, seeking to include companies that may not have been previously included. This has muddied the clearer disclosure norms for group companies that existed, as it is not clear which accounting standards need to be applied. The new Indian Accounting Standards will further add to this ambiguity, as some terms used differ from those in the Companies Act, 2013.
Furthermore, processes carried out by auditors in terms of the extant accounting standards and disclosures made in the financial statements are limited to parties with whom transactions are undertaken in the relevant period and do not normally cover the wider universe of related parties. This one-size-fits-all policy of disclosure while not necessarily serving the interests of investors will substantially increase transaction costs and the time associated with the process, which is contrary to the recent efforts by SEBI.
SEBI has also made significant efforts in the recent past to reduce the turnaround time for reviewing draft offer document. It has reduced the time period from more than six months in some cases to around two to three months. Further, SEBI has also eased disclosure and eligibility norms for companies undertaking rights issuances or further public offerings. This has led to a proliferation of activity in Indian capital markets.
Securities regulators face a tough task as they need to protect investor interests while also working for the development of the securities market. This is a bigger challenge for economies such as India, where the securities market is often viewed as a barometer of the country’s overall economic position. SEBI has therefore needed to react to changing market environments and has generally kept introducing amendments to securities regulations to keep pace with India’s growth story.
SEBI has also recently adopted a consultative approach towards the framing and implementation of regulations. This is encouraging as it is the intermediaries that execute the transactions who face practical challenges. However, challenges remain with respect to due diligence and disclosure requirements and SEBI will therefore need to continue to partner with market intermediaries to ensure that such challenges are clearly identified and addressed on an ongoing basis.
Varoon Chandra and Lionel D’Almeida are partners in the capital markets practice at AZB & Partners in Mumbai.