Enforcement action in the US
In March 2020, the Securities Exchange Commission (the “SEC”) formed a Coronavirus Steering Committee to actively oversee the monitoring of COVID-19-related misconduct by listed entities. On December 4, 2020, the SEC issued its first enforcement order against a listed entity for making misleading disclosures about the financial impact of the pandemic.
In its order against Cheesecake Factory Incorporated, the SEC held that the company’s disclosures stating that it will continue to “operate sustainably” were materially false and misleading. The SEC arrived at this conclusion as the company failed to disclose details of its losses and of a significant decrease in its cash reserves. More importantly, the SEC issued the order despite the fact that the company continued to remain in business as on the date of the order (i.e., nine (9) months after the date of the disclosure), and its stock price closed near the high of its fifty-two (52) week range. Noteworthy, the company was penalized despite technically fulfilling its commitment to “operate sustainably.”
The SEBI Advisory
To ensure that market participants and investors receive adequate information, the Securities and Exchange Board of India (the “SEBI”) issued an advisory on May 20, 2020 directing listed entities to disclose material information regarding the financial impact of the COVID-19 pandemic (the “SEBI Advisory”).
Existing disclosure requirements
Regulation 30(3) of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (the “LODR”) already requires listed entities to make disclosures regarding certain specified events on the basis of SEBI’s guidelines for materiality, including, disclosure regarding any disruption of operations caused by natural calamities, force majeure events, or events such as strikes and lockouts.
SEBI’s circular dated September 9, 2015, provides guidance to listed entities on the type of information which is required to be disclosed under the foregoing requirement. The circular requires listed entities to disclose information, both, at the time of occurrence and periodically until the restoration of complete normalcy.
At the time of occurrence, the information required to be disclosed by listed entities includes: (i) the expected quantum of loss/damage caused; and (ii) whether the loss/damage was covered by insurance along with the sum insured. The information required to be disclosed periodically includes: (i) the insurance amount claimed and realized; (ii) the actual amount of damage caused; (iii) details of steps taken to restore normalcy; and (iv) the impact on production, services, and financials of the entity.
Separately, in respect of non-convertible securities, Regulation 51 of the LODR specifically requires listed entities to disclose all information which has a bearing on its performance, operations, or price-sensitive information. Further, listed entities are also required to disclose any action which affects payment of interest or dividend of non-convertible preference shares or redemption of non-convertible debt securities or redeemable preference shares.
Directions under the SEBI Advisory
Prior to the issue of the SEBI Advisory, several listed entities made disclosures under the foregoing provisions, including, disclosures regarding shutdown of operations, and actions taken towards sanitation and safety. However, they did not make qualitative and quantitative disclosures of the financial impact of the pandemic on their business, performance and operations.
Given this, the SEBI Advisory specifically directs entities to disclose the financial impact of the pandemic and provides an illustrative list of required disclosures, which includes information regarding:
- Impact of the COVID-19 pandemic on the business;
- Ability to maintain operations, including, the factories/units/office spaces functioning and closed down;
- Schedule, if any, for restarting the operations;
- Steps taken to ensure smooth functioning of operations;
- Estimation of the future impact of COVID-19 on operations;
- Details of impact of COVID-19 on the entity’s: (i) capital and financial resources; (ii) profitability; (iii) liquidity position; (iv) ability to service debt and other financing arrangements; (v) assets; (vi) internal financial reporting and control; (vii) supply chain; and (viii) demand for its products and services;
- Existing contracts/agreements where non-fulfillment of the obligations by any party will have a significant impact on the entity’s business; and
- Other relevant material updates about the listed entity’s business.
Additionally, the SEBI Advisory requires listed entities to provide regular updates of material developments to ensure the availability of continuous information about the financial impact of the pandemic on an entity’s operations. In addition, it encourages entities to include the relevant information in their financial statements required to be submitted to the SEBI under Regulation 33 of the LODR. Furthermore, it discourages entities from resorting to selective disclosures.
Impact of the SEBI Advisory
Several listed entities have made disclosures regarding the impact of the COVID-19 pandemic since the issue of the SEBI Advisory. However, press reports suggest that while most entities have complied with the procedural requirements, entities have failed to follow the spirit and intent of the SEBI Advisory. Coupled with the SEBI’s lack of enforcement of these requirements, subsequent events have caused the SEBI Advisory to become a toothless measure.
For instance, several entities have chosen to focus on the short-term impact without disclosing the long-term effects of the pandemic. A number of entities have failed to disclose the impact on key factors such as cash flow, manufacturing and supply chain models, inventories, debt levels and profitability. Instead, entities have issued vague statements in respect of the impact, including, statements highlighting their commitment to: (i) reduce costs; (ii) continuously monitor operations, and internal and external information; and (iii) increase operating profits. In other cases, entities merely disclosed that the ongoing events have had an impact on their plants, equipment, assets, inventories and trade receivables without detailing the extent of the impact.
The SEBI has correctly identified the need for listed entities to provide material information regarding the financial impact of the COVID-19 pandemic to market participants. However, the events which have taken place since the issue of the SEBI Advisory suggest that, both, the SEBI and listed entities, are treating the SEBI Advisory as a mere procedural formality. Given this, there continues to be a large gap in the material information available to investors regarding listed entities’ financials.
As such, in our view, the SEBI should contemplate initiating proceedings, similar to the SEC’s action in the US against Cheesecake Factory Incorporated, to underscore the importance of COVID-19 disclosures and to compel listed entities to make appropriate disclosures or revise existing ones depending on business dynamics. Only then will market participants understand the state of the business in any entity and whether things are being brushed under a carpet.