Insider trading, allegations of malpractice, and governance issues are the worst woes to strike a company, where much depends on investor confidence. In the wake of the whistleblower troubles surrounding Infosys, and scrutiny from the regulator, it is crucial to delineate what goes into determination of materiality of information (in this case, whistleblower complaints), and the timing of making disclosures to public.
As events unfold, Infosys, once India’s IT dream, is at the helm of public and regulatory scrutiny for whistleblower complaints alleging unethical practices adopted by C-Suite employees, material accounting irregularities and withholding of information relating to financials and commercial deals from auditors and Infosys board. While the anonymous whistleblower complaints were received by a director on September 30, 2019, Infosys made a disclosure of the fact of receipt of these complaints only much later, on October 21, 2019 (when the complaints became public), followed by a detailed disclosure setting out the manner in which the complaints were being handled on October 22, 2019. In the meantime, US SEC has also initiated a probe against Infosys on the whistleblower complaints, since its American Depository Receipts are listed in New York. To make matters interesting, unusual trading patterns have emerged, where traders have built up huge short positions through derivatives right before the whistleblower complaints came into light. As per information available publicly, these derivatives are alleged to be coupled with put options or right to sell shares at a fixed strike price, and when stocks of Infosys plummet over the allegations, the holders of these derivatives are likely to book profits.
Non-disclosure of complaints
Sebi is now investigating Infosys for non-disclosure of the whistleblower complaints as material price-sensitive information, alleged corporate governance lapses and suspicions of insider trading over the built up in short positions. Earlier this year, Sebi imposed huge fines on NDTV for its failure to make timely disclosures of certain tax orders.
To ensure strict corporate governance standards, Sebi laws arm companies with both, ability to take preventive measures (through code of conducts, monitoring mechanisms for insider trading and whistleblower policy), and remedial actions in case of information leaks (by mandating immediate and timely disclosures of price sensitive information to the public shareholders). For making such disclosures, information is categorised broadly into two buckets, i.e. information / events which require ‘deemed material’ disclosures, and information / events which require the board of directors to disclose information, which in the ‘opinion of the board’ are material. When boards exercise their discretion in determining materiality of information for disclosure, it is imperative to weigh in both, the obligation to maintain information symmetry in the market (of price sensitive information), against the risks of a premature disclosure.
Practically, boards for exercising this discretion, often find themselves looking for guidance on what can be considered ‘material information’. Sebi offered an aid to boards by mandating that companies adopt a policy for determining materiality of disclosures, based on certain principles identified under the SEBI (Listing and Disclosure Obligations) Regulations 2015. One such principle is to determine whether omission of such information is likely to result in ‘significant market reaction’ if it comes to light at a later date. However, most often than not, the policies adopted by companies are largely subjective, if not a reiteration of the principles prescribed, and offer little practical guidance.
Leeway to companies
When it comes to whistleblower complaints, there is no straightjacket formula to determine materiality and it is the underlying allegations which need an assessment. A circular issued by stock exchanges last year prescribes a few standards here, requiring companies to disseminate material information as soon as these are ‘credible and concrete’, and immediate
suo moto disclosures in case of media rumors or information leakage. Companies need to ensure that material price sensitive information is disseminated as soon as any information leakage is known with reasonable level of correctness. There is some leeway given to companies to choose if a disclosure is required, in case there is a likelihood of crystallisation of information / underlying events (such as contingent liability or dispute settlements), but finality has not been reached. The spirit of the law is to ensure that companies maintain protocols for information symmetry where the underlying information has the potential to influence the market or result in speculative trading. As such, both timing of disclosure and materiality of information go hand in hand.
Allegations of unethical practices adopted by key managerial persons (KMPs) in relation to accounting policies and financials (including withholding of information from auditors), as in the case of Infosys, are serious concerns. Sebi laws, in particular, require any fraud or defaults by KMPs as ‘deemed material’ and require immediate disclosure within 24 hours. However, it is important to consider if such a disclosure is even required to be made, until the investigation completes, and allegations are proven. It also merits a question if the complaints should be viewed in light of the circumstantial facts of an existing vigil mechanism which was not availed, announcement of a class action suit in US, and suspicions of insider trading with the short positions.
Proper protocols needed
In any case, having adequate protocols can provide safe harbours to companies for avoiding potential shareholder claims or better still, class action suits, as in the case of Infosys, for dissemination of “materially misleading business information to public shareholders”. Further, when boards face themselves staring at allegations of malpractice involving C-suite employees or financial irregularities, the role of independent directors also becomes crucial in insisting on timely disclosures to public and upholding governance standards. Deft precautionary measures, with nimble disclosures by companies can go a long way in handling market trepidation and avoiding inklings of speculative or even insider trading. It is a fine line, but to be tread carefully.
Aakash Choubey is Partner and Shreya Dua is Senior Associate at Khaitan & Co, one of India’s oldest and largest law firms. The views of the authors in this article are personal and do not constitute legal / professional advice of Khaitan & Co.