Building Compliance Resilience
In conversation with Bharat Vasani, Partner, General Corporate, TMT Practice, Cyril Amarchand Mangaldas
Executive Summary
A widening trust deficit between regulators and businesses is giving rise to a more rule-based, enforcement-focused system.
SEBI plans to amend the LODR rules to make them more prescriptive, in the process removing much of the discretion that CFOs earlier had.
The already-amended PFUTP rules categorise any manipulation of financial records that impacts share prices – even the addition of certain items to contingent liabilities – as fraud.
In a number of areas, rules and regulations are expected to change in the coming year:
1. RPTs: The threshold for obtaining shareholder approval has been lowered on RPT transactions. Unrelated counter party transactions will also come under the approval purview, effectively increasing the cost of compliance.
2. Proposed changes to Regulation 30: SEBI is set to expand the scope of events in Paragraph A and add certain conditions for disclosure in Paragraph B (which are currently discretionary). This will meet the ‘materiality’ policy objective and remove the current distinction between Paras A and B.
3. Disclosure regime: Going by recent SEBI consultation papers, the regime will become more stringent, and existing agreements will need to be ratified by stakeholders, including the majority of minority stakeholders.
India’s legal and regulatory landscape is fast evolving, with the trust deficit between businesses and regulators widening dramatically. From being mainly principles-based, regulation is increasingly becoming rules-based and the regulators more enforcement/prosecution-focused. With the Companies Act, Ind-AS and the SEBI (LODR) regulations all at play, corporates face a complex regulatory cocktail and a rising compliance burden. At a recent India CFO Forum session in Mumbai, Bharat Vasani, Partner, General Corporate, TMT Practice, Cyril Amarchand Mangaldas, decoded some of the recent changes and their implications for business.
A Compliance Minefield…
Symptomatic of the growing distrust are the planned amendments to SEBI’s Listing Operation and Disclosure Requirement (LODR) rules. Earlier, these were principles-based and companies were trusted to follow broad rules, but they may soon be made prescriptive, wherein everyone, including Company Secretaries, will be penalised for not complying with set rules. Moreover, SEBI’s amended Prohibition of Fraudulent and Unfair Trade Practices rules now categorise any manipulation of a company’s financial records that impacts security prices as ‘fraud’. This removes the discretion CFOs earlier had in terms of adding certain liabilities to contingent liabilities. SEBI is also set to go after Independent Directors in cases of non-compliance by their company, even if they are not involved in daily operations. Separately, the Supreme Court has become stricter about corporate governance issues, and a number of proxy advisory firms have cropped up, putting the spotlight on listed companies.
Upcoming Regulatory Developments
Related-party transactions
SEBI has lowered the threshold for obtaining shareholder approval for transactions, including related-party transactions (RPTs), to Rs 1,000 crores or 10% of a listed entity’s annual turnover – whichever is lower.
Critically, transactions involving unrelated counter-parties are now also covered, which implies that any transaction by the holding company or its subsidiaries (including foreign ones) may require approval.
The application of this rule to foreign subsidiaries can create issues by undermining the autonomy of Boards. Since SEBI does not hold extra-territorial powers, the feasibility of this change is yet to be established.
Under the UK’s Premium Listing Rules, from where this is borrowed, transactions in the ordinary course of business are exempt, but the same is not true for India.
Proposed changes to Regulation 30
Paragraph B of Regulation 30(4) contains an important loophole. Specifically, a vague materiality clause allows firms to avoid disclosing events/information that can potentially wipe out almost 50% of the company’s net worth.
To correct this, SEBI plans to expand the scope of Paragraph A to make it mandatory to report events that affect 2% of net worth, 2% of turnover or 5% of the 3-year average PAT. This will meet the ‘materiality’ policy objective and remove the current distinction between Paras A and B.
Companies will have to actively scout for any news/rumour about them and report it to SEBI. This will increase the amount of negative news – including retrospective news – reported against the company. In turn, this may adversely impact share prices.
Strengthening corporate governance
SEBI has also released a consultation paper proposing changes that will make the disclosure regime more stringent:
If an agreement impacts management or imposes a restriction/liability on a listed entity (irrespective of whether the listed entity is a party), such agreements have to be approved by the Board on the grounds that they may impact the company's economic interest.
Existing agreements will need to be ratified by shareholders, including the majority of minority shareholders.
Vacancies for the positions of MD, CEO, WTD, CFO, or compliance officer will need to be filled within 3 months from the date of vacancy.
For non-retiring NEDs, their continued directorship will require shareholders’ approval at least once every 5 years.
In case of non-compliance, in addition to a penalty of up to Rs 25 crores, SEBI has proposed allowing for the demat accounts of the MD, CFO and other KMPs to be frozen.