Defining USPI

Today's Financial Express has a piece by @_baldemort__ @JRishabh2001 and me on the proposed expansion of the definition of what would constitute material under a relook at the listing regulations, to make them more in line with the definition of material in the insider trading regulations. While broadly ok, there are certain areas of caution. For instance pre-mature disclosure will chill forensic audit, because no company would like to attract negative attention till the forensic report actually finds wrong-doing. That would be a regulatory self-goal. The full piece is copied below:

The Securities and Exchange Board of India (“SEBI”) released a consultation paper on November 9, 2024 proposing revisions to the definition of Unpublished Price Sensitive Information (“UPSI”) under the SEBI (Prohibition of Insider Trading) Regulations, 2015 (“PIT Regulations”). To this effect, SEBI has introduced thirteen (13) new proposals to broaden the scope of the UPSI definition to include certain material events specified under the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (“LODR Regulations”). These include, among others, upward or downward revisions of credit ratings, proposed fund-raising activities to be discussed at Board meetings, agreements impacting the management and control of the company, initiation of forensic audits, outcomes of certain litigations, and the award or termination of significant contracts or orders not in the ordinary course of business. Some additions are well-founded, as such events significantly influence investor decisions and market movements. However, certain inclusions may dilute the framework's purpose by covering routine operational matters or classifying less material disputes as UPSI.

The relationship between material events and UPSI has evolved over time. Initially, the definition of UPSI under the PIT Regulations included within its scope, information related to all material events as per the listing agreement. However, an amendment to the PIT Regulations in April 2019 removed the direct link to materiality. Instead, listed entities were required to exercise judgment and prudently classify information as UPSI to align with the intent of the PIT Regulations. Despite this, instances of failing to categorize information, apart from those explicitly specified under the PIT Regulations, continued to persist. SEBI noted that listed companies were not exercising due care to classify or consider certain price sensitive information as UPSI. To address this issue, SEBI released a consultation paper on May 18, 2023, proposing to align the definition of UPSI with material events under Regulation 30 of the LODR to improve clarity and ensure consistent compliance.

In its latest consultation paper released on November 9, 2024, SEBI aims to address concerns raised in public feedback regarding the proposal to include material events under Regulation 30 of the LODR Regulations within the definition of UPSI. These include concerns over the limited impact of all Regulation 30 events on securities prices, recommendations to prioritize specific material events, and difficulties in compliance management. In this context, determining whether a material event falls within the scope of UPSI requires evaluating whether events warranting disclosure are, in most cases, also price-sensitive.

The new proposals recommend including regulatory actions against the listed entity, its directors, key managerial personnel (“KMPs”), and subsidiaries within the definition of UPSI. However, not all regulatory actions or orders carry the same level of significance or are likely to impact prices. For example, regulatory actions such as notices resulting in minor penalties for technical defaults are unlikely to have a substantial effect on stock prices. Similarly, actions against non-material subsidiaries that are not directly involved in the listed entity’s core and major operations may not significantly alter market perception. More importantly, even if material, ‘action initiated’ should never be the standard for disclosure. Everyone is assumed innocent unless proven guilty. To put in public domain a very preliminary charge or prima facie case would be unfair to the individual or company being investigated, ruining their image, even if ultimately exonerated. The only acceptable standard must be when a person is indeed found to have committed a wrong.

The Consultation Paper also proposes including changes to KMPs within the UPSI definition, even in cases unrelated to governance concerns, disputes, or financial irregularities. Additionally, it suggests incorporating information about the outcomes of litigation or disputes that could impact the listed entity. While rulings that result in significant financial liability may affect stock prices, outcomes that are pre-disclosed or anticipated, where the market has already priced in the potential impact, may not always be price-sensitive. As a result, events covered under Regulation 30 of the LODR Regulations require further independent analysis of their price sensitivity to determine whether they should be included within the scope of UPSI.

However, proposals for information such as upward or downward changes in ratings are inherently price-sensitive, as they directly affect the perception of a company’s creditworthiness or risk profile and are closely monitored by investors. Similarly, including award or termination of order/contracts not in the ‘normal course of business’ is justified because both the award and termination of contracts outside the normal course of business often indicate significant changes to the company's future cash flows, market position, or operational strategy. These events could lead to price movements. Of course, a material filter should also be applied, as a Re. 1 outside normal course of business contract should not be required to be disclosed.

 

The proposal to include information in relation to initiation of forensic audit or receipt of final forensic audit may raise speculations about potential mis-statements, misappropriations, or irregularities in a company’s financial dealings is too pre-mature. Indeed, if at the preliminary stage this is required to be disclosed, few companies would initiate a forensic audit for the fear of bad press. Indeed, the company would get bad press if and when a finding of mis-statement is found by the forensic report. Mandating a disclosure pre-maturely would be a regulatory self-goal.

At this juncture, it is important to note that the definition of UPSI is intended to be inclusive, already covering disclosures under the LODR Regulations that may be price-sensitive. The current proposals reflect SEBI's intention to better align its regulations with the realities of market dynamics. By broadening the definition of UPSI to include material events required to be disclosed under Regulation 30 of the LODR, SEBI acknowledges that certain events, even if they are not inherently market-sensitive at first glance, could have significant implications for investor perception and are not currently being disclosed. As a free market supporter, the authors believe in the current approach, but SEBI may be right in changing standards if it has data that people are being too cute with disclosures.

Through this approach, SEBI seeks to capture a wider range of corporate actions and events that could influence the financial standing or public perception of a listed entity. However, this broad interpretation introduces complexity, as it may lead to the classification of at least some routine operational events as UPSI, even if their market impact is limited or uncertain. Similarly, some other concerns with respect to forensic audits and under investigation or under enforcement events should not be disclosed till a finding of fault.

SEBI's proposed revisions to the UPSI definition aim to address changing market conditions and improve investor protection. Expanding the scope to include more material events under the LODR Regulations helps with clarity and compliance. However, it also creates challenges in distinguishing between price-sensitive information and routine operational matters. A consistent and focused approach, based on the likelihood of an event affecting market prices, reducing adverse impact on innocents and preventing self-audits by pre-mature disclosure would ensure that only truly relevant disclosures are classified as UPSI. This approach would help maintain the effectiveness of the insider trading regulations, reduce unnecessary compliance burdens while aligning the rules with current market practices.