SEBI, India Inc must disclose companies under investigation

Is a formal probe by market regulator Securities and Exchange Board of India for violation of securities laws, material information for an investor? Most, if not all, Indian companies don’t think so. And it appears that even the regulator does not have a clear view on whether companies are required to disclose such information to the stock exchanges. It is not surprising then that investors get to know about a company falling foul of the regulator, only after the final order in the case is passed.

Take the following instances.

[caption id=“attachment_103175” align=“alignleft” width=“380” caption=“Anil Ambani, chairman of the Reliance Anil Dhirubhai Ambani Group. Reuters”]  [/caption]

In January this year, Sebi barred Anil Ambani group companies, Reliance Infrastructure (R-Infra) and Reliance Natural Resources Ltd (now merged with Reliance Power), from investing in the secondary markets till December 2012 for certain transactions in violation of rules. In addition, Anil Ambani and four senior executives of the group paid Rs 50 crore in their personal capacity, under a consent order, without admitting or denying the charges. Shares of both Reliance Infra and Reliance Power fell sharply in the trading session after the orders were issued. The show cause notice on the matter was issued in June 2010, and in August 2010, the regulator called Reliance Infra, RNRL, senior officials from both companies, and Mr Ambani, for a personal hearing in the case. Sebi however did not specify the details of the case, in the circular it put up on its web site. And there was no communication from Reliance Infra or RNRL about the directives from Sebi.

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In November 2006, Sebi held the chief financial officer of pharmaceutical firm Wockhardt guilty of insider trading charges. Unlikely, that the regulator would not have informed the company at the time of proceeding with the investigations. But the company did not intimate the stock exchanges about any such probe, despite it involving a very senior official. The verdict was subsequently upheld by the Securities Appellate Tribunal in May 2008, and later by the Supreme Court. Wockhardt eventually settled the case under a consent order in April 2009.

Or take the case of India’s largest private sector company, Reliance Industries.

The petrochemical-petroleum giant is facing insider trading charges after some entities affiliated to the group short sold Reliance Petroleum futures just a few days before RIL offloaded a 4% stake in RPL in November 2007. According to media reports, Sebi issued a show cause notice in the matter in May 2009, followed by fresh show cause notice in November 2009. The insider trading probe is among the factors that have caused the stock to underperform in the last couple of years. Media reports further say that the company has been unsuccessful in its attempts to settle the case with the regulator, who is demanding a much bigger fine than what RIL is willing to pay. On its part, RIL has not denied the probe and has been quoted in media repudiating the charges and having provided the relevant details to the regulator. But there has been no formal communication to the stock exchange about the show cause notices. So an investor wanting to know if at all the company is being probed by the regulator, by looking up the stock exchange disclosures, will not find anything. He will have to solely rely on the authenticity of media reports. And with due credit to all news organizations, the stock exchange website remains the most reliable source of information for the average investor.

Companies don’t need to disclose having received show cause notices from investigating agencies/regulator. After all, a show cause notice is not an indictment of any wrong doing, and may not necessarily lead to legal proceedings. It is merely an opportunity for the company to defend its action(s). But if the regulator is not convinced by the company’s reply, and decides to proceed with the investigations, should the company be formally notified, and the company in turn be expected to make the disclosure to the stock exchanges? After all, isn’t a regulatory probe something that is likely to impact the stock price, and hence qualifies as a material disclosure?

But this issue about probe disclosures is not unique to the Indian market. Even a developed market like the US is debating on what and when should companies disclose in their filings on investigations by the Securities Exchange Commission (SEC).

There is something called the Wells notice, which is given by the SEC’s enforcement division when it is plans to press charges for a violation of the securities laws. But not every Wells notice results in litigation, and companies often settle with the regulator. So that raises the question whether companies should be disclosing receipt of Wells notice, if it is not always going to end up in litigation. In 2010, rating agency Moody’s mentioned the Wells notice in its filing, but only seven weeks after receiving it. The SEC had said it would press charges against Moody’s for making misleading statements in its 2008 filings. Goldman Sachs on the other hand, never disclosed the Wells notice it was served in 2009, nine months before being charged of defrauding investors through its financial product Abacus, linked to sub-prime mortgages. Eventually, the Financial Industry Regulatory Authority (FINRA) fined Goldman $650,000 for failing to disclose the Wells notice.

So whether in India or the US, on the matter of disclosing regulatory probes, much depends on the interpretation of the term “material information.”

Listed Indian companies have to mandatorily disclose regulatory probes against them, but that is only if they are tapping the capital market again to raise funds.

The term “material information” may be open to interpretation, but there is something as being fair while making disclosures.

Here are a couple of lines from the report of the Technical Committee of the International Organization of Securities Commissions (IOSCO), an association of organisations that regulate the world’s securities and futures markets.

The report, released back in 2002, is titled ‘Principles for Ongoing Disclosure and Material Development Reporting by Listed Entities.’

Among other things it says: “The fundamental principle of full and fair disclosure is that the listed entity should provide all information that would be material to an investor’s investment decision. Material information should be updated and provided on an ongoing basis to the public, so that retail investors who participate through secondary trading, and who are most in need of regulatory protection, can benefit from this same type of disclosure on an ongoing basis.”

Something like a regulatory probe, that could easily impact the stock price, should easily qualify as material information.

But forget formal statements by Indian companies on regulatory probes against them. Just check how many companies disclose to the stock exchanges, regulatory actions against them such as fines and debarments.