ANALYSIS OF CONCEPT OF MATERIALITY

ANALYSIS OF CONCEPT OF MATERIALITY

INTRODUCTION

In recent years, India has witnessed a significant surge in investments across various sectors, marking a promising trend for the country's economic growth.1 This increase in investments can be attributed to several factors, including the Indian government's proactive efforts to improve the ease of doing business and implement investor-friendly policies such as the Goods and Services Tax Act, 2017 which has simplified the tax structure, making it more transparent and investor-friendly. Additionally, the Indian government has introduced amendments to the Insolvency and Bankruptcy Code, 2016 in subsequent years thus streamlining the process of resolving insolvency issues and enhancing creditor rights. The Government has relaxed foreign investment guidelines which in turn has promoted foreign direct investment.

Additionally, India's burgeoning consumer market driven by the upper middle class, skilled workforce, and a growing appetite for innovation have attracted both domestic and international investors. The sectors experiencing the most substantial investment inflow range from technology and renewable energy to healthcare and infrastructure development.2 As the nation continues to make strides in its economic policy reforms and infrastructural improvements, the rise in investments in India is poised to further bolster its position as a global investment destination.

In furtherance of the above, the Indian government has been proactively revamping its legal framework governing securities by acting through the Securities and Exchange Board of India (“SEBI”), wherein SEBI introduced quantifiable metrics to determine materiality via SEBI (Listing Obligations and Disclosure Requirements) (Second Amendment) Regulations, 2023 (“Amendment Regulation”) which is in addition to the existing qualitative metrics for determining materiality of an event for listed companies as per the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (“LODR Regulations”).

It cannot be disputed that SEBI has taken positive steps to clarify and enhance disclosure mechanisms through the Amendment Regulation. However, there seems to be room for further consideration regarding the role of investors in determining necessary disclosures. This article delves into this issue and elucidates upon the significance of investors’ requirements when it comes to extent of disclosures.

ROLE OF SEBI

Before analyzing the changes made to the LODR Regulations by the Amendment Regulation, it is pertinent to understand the rationale behind SEBI bringing the Amendment Regulation into effect, the following is the purpose behind introduction of the Amendment Regulation (“Purpose”)3:

1. specifying thresholds for and increasing the scope of disclosures;
2. sale, disposal or lease of assets of a listed entity outside schemes of arrangements; and
3. specifying thresholds for matters that require disclosure and identifying matters that require shareholders’ approval.

Upon examination of the Purpose, it becomes evident that SEBI is advocating for more transparent corporate governance standards. This encompasses a greater role for shareholders, expanded disclosure requirements for listed entities, clearly defined procedures for appointing and removing key managerial personnel, implementation of strict disclosure timelines and quantifiable Materiality (as defined below) thresholds.

In this article, our analysis will be confined to the concept of Materiality, a fundamental element in the regulatory framework of the Indian financial markets. Materiality, in this context, refers to the importance of information or events that can potentially impact investors' assessments, financial performance, or the stock price of a company (“Materiality”). The Materiality threshold as it stands post Amendment Regulation is as follows (“Materiality Thresholds”):

1. “the omission of an event or information, which is likely to result in discontinuity or alteration of event or information already available publicly; or
    
2. the omission of an event or information is likely to result in significant market reaction if the said omission came to light at a later date; or
    
3. the omission of an event or information, whose value or the expected impact in terms of value, exceeds the lower of the following4:

• two percent of turnover, as per the last audited consolidated financial statements of the listed entity;
• two percent of net worth, as per the last audited consolidated financial statements of the listed entity, except in case the arithmetic value of the net worth is negative;
• five percent of the average of absolute value of profit or loss after tax, as per the last three audited consolidated financial statements of the listed entity;”

4. In case where the criteria specified in sub-clauses (a), (b) and (c) is not applicable, an event or information may be treated as being material if in the opinion of the board of directors of the listed entity, the event or information is considered material”.

The amendment introduced by the Amendment Regulation marks progress in the domain of Materiality determination in India. It strives to blend a quantitative approach by identifying measurable parameters and also affording listed entities the flexibility to assess materiality in a more qualitative manner. This approach avoids rigidly confining the scope of determining materiality to the quantifiable aspects of the Materiality Thresholds as introduced by the Amendment Regulation.

DRAWBACKS

Nonetheless, SEBI's current approach does not fully address some of the challenges confronted by listed entities in India when assessing Materiality. These practical issues have been experienced in day-to-day operations and by SEBI's adjudicatory body. The shortcomings of the materiality framework introduced by the Amendment Regulation can be summarized as follows:

1. The determination of qualitative aspects of materiality thresholds is largely at the discretion of the listed entity and its directors, thus leaving the investor basing their decision to invest on the discretion of the listed entity and its directors;

2. Prejudicing smaller scale listed entities by placing additional disclosures on them which might not be material to the investor; and

3. The quantifiable aspect of materiality thresholds provides room for listed entities to potentially omit the disclosure of material information that could be of relevance to investors.

Thus, it can be concluded that SEBI has not adopted an investor friendly approach, wherein the investors are provided with an opportunity to determine the Materiality of the information. This could lead to multiple issues already being faced by SEBI in respect of erroneous disclosures6 due to selective interpretation of the LODR Regulations7 and not considering the investors’ interest in any scheme, business transaction or arrangement.

RECOMMENDATIONS

While India has embraced a balanced approach in the determination of Materiality, a concept that is required for the current state of the Indian economy. This approach needs to change in light of the rapid increases that the executive branch of the Indian government is aiming to bring into the economy via promotion of foreign investments and making a conducive domestic investment which promotes investments. In light of these actions by the Government, it is pertinent to understand an investor friendly approach as adopted by the government of the United States of America, wherein the Securities and Exchange Commission (“SEC”), via their provisions and rules promote the concept of determining “material” information by understanding and limiting the information disclosed based on an average prudent investor ought reasonably to be informed before purchasing the registered security. The view adopted by the SEC was further affirmed by the US Circuit Court of Appeals8 and the Supreme Court9, thus promoting the investor friendly culture in their country, which in turn fostered an advanced economy.

CONCLUSION

Thus, while the approach adopted by SEBI and brought into force by the Amendment Regulation cannot be dismissed entirely, there are minor changes that are required to change the approach being prescribed by the Amendment Regulation, particularly in respect of taking into consideration the importance of investor’s perspective and providing an opportunity to the investor to determine what information is material and what is not. This is crucial as disclosure of more information than what is required may be dubious in nature. Thus, it is essential for the investor to be involved in determining the policies of Materiality or what is material information so as to understand what information is absolutely necessary to be disclosed for making an informed decision, which is the aim of disclosures and determining the Materiality of an event.

ENDNOTES

• Press Release, India’s Growth to Remain Resilient Despite Global Challenges, (August 11, 2023, 11:44 A.M.). India’s Growth to Remain Resilient Despite Global Challenges (worldbank.org)
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• Blog, Best Sectors to Invest in India in 2023, (August 11, 2023, 12:45 P.M.). Top Investment Sectors in India for 2023 | Motilal Oswal
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• SEBI, Consultation Paper, 2023, (August 12, 2023, 1:30 P.M.). SEBI | CONSULTATION PAPER ON STRENGTHENING CORPORATE GOVERNANCE AT LISTED ENTITIES BY EMPOWERING SHAREHOLDERS – AMENDMENTS TO THE SEBI (LODR) REGULATIONS, 2015
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• Regulation 30(4) of SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (last amended on June 14, 2023).
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• Regulation 30(4) of SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (last amended on June 14, 2023).
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• D S Kulkarni Developers Limited (Adjudication Order No: Order/KS/VC/2019-20/6636).
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• Oregon Commercial Limited (Adjudication Order No. EAD-9/ AO/SM/ 63/2018-19).
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• Dalberth v. Xerox Corp., No. 13-1658, 2014 WL 4390695, at 10 (2d Cir. Sept. 8, 2014).
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• Halliburton Co. v. Erica P. John Fund, Inc., 134 S. Ct. 2398, 2413 (2014).