On November 14, 2019, almost a decade after the initial public offering of Electrosteel Steels Limited (Electrosteel), the Securities Appellate Tribunal (SAT) delivered its judgment in Electrosteel Steels Limited v. Securities and Exchange Board of India (the SAT Order). It partially upheld the judgment dated March 31, 2016 (SEBI Order) of the adjudicating officer of the Securities and Exchange Board of India (SEBI). The SAT Order has discussed the concept of ‘materiality’ in the context of disclosure in offer documents.
Background and Proceedings before SEBI
In 2016, SEBI considered whether the rejection of an application made by Electrosteel Castings Limited, the promoter of Electrosteel, to the Ministry of Environment and Forest (as it then was) in relation to the diversion of forest land for an iron ore mine located at Kodolibad, Jharkhand (the MoEF Application), was ‘material’ information required to be disclosed in the offer documents relating to Electrosteel’s initial public offering (the IPO).
Through the SEBI Order, SEBI held that the rejection of the MoEF Application was ‘material’ information. Accordingly, failure to disclose the rejection of the MoEF Application in the IPO offer documents was in violation of the disclosure requirements set out in Regulations 57(1) and 57(2)(a) of the Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2009 (the 2009 ICDR Regulations), which mandated disclosure of all material information relevant to exercise an informed investment decision and disclosure of a prescribed list of items, respectively.
In relation to what constitutes ‘material’ information for purposes of disclosure, SEBI observed that: “‘Material disclosure’ has to be determined objectively from the view point of a reasonable investor….assessment of the materiality of an event or development requires a contextual determination that takes into account all of the relevant circumstances, including the nature of the event or development and its consequences to the issuer’s business…Further, the subjective views of the issuer, if any, thus, does not factor into this analysis. Thus, true and adequate disclosure is said to be made, if the disclosure is accurate and not misleading and does not omit a fact that is either material itself or is necessary to understand the facts that have been disclosed, so as to enable the investors investing in the issue to take an informed investment decision…The test for materiality is objective in nature and is not affected by the subjective assessment or optimistic hopes or views of the [Book Running Lead Managers] and the issuer company.” In its findings, SEBI took a stand that a subjective assessment by the issuer could not determine what constitutes ‘material’ information for disclosure. Instead, SEBI favoured an assessment from the reasonable investor’s perspective.
Pursuant to its observations, SEBI held that the merchant bankers’ failure to disclose the rejection of the MoEF Application was premised on a hypothetical assumption that a re-filed application would be accepted by the Ministry of Environment and Forest. Accordingly, in SEBI’s view, the merchant bankers had failed to discharge their due diligence obligations under the 2009 ICDR Regulations by not disclosing the rejection of the MoEF Application. SEBI imposed a consequent penalty of Rs. 1 crore on each merchant banker, Rs. 1 crore on Electrosteel and Rs. 50 lakhs on Electrosteel Castings Limited.
Proceedings before SAT
Sitting in appeal over the SEBI Order, SAT upheld SEBI’s factual finding that the rejection of the MoEF Application was ‘material’ information that should have been disclosed in the IPO offer documents. Whilst upholding the SEBI Order, SAT observed in relation to materiality of information: “The letter and spirit (as well as absence of pictures) of the disclosure requirement is the need for disclosing all material events in clear terms with very little discretion for judging the degree of materiality. The emphasis is on disclosure; not otherwise, which means disclose even when the issuer doubts whether there is any materiality. In other words, it would imply that only facts/ events which the issuer is undoubtedly sure of having no relevance to the issuer or to the issue can be excluded from disclosure” (emphasis supplied).
However, SAT held that the failure to disclose the rejection of the MoEF Application did not merit imposition of the highest penalty available under law. Accordingly, SAT reduced the penalty imposed on Electrosteel to Rs. 50 lakhs and on the merchant bankers to Rs. 50 lakhs, to be paid jointly and severally.
Impact of the SEBI Order and SAT Order
In its present form, the disclosure regime under the 2018 ICDR Regulations (and under the now inapplicable 2009 ICDR Regulations) applies a general materiality standard to all information and prescribes specific disclosure requirements. The plain text implications are clear: there must be disclosure of (i) various items deemed material by the regulator for investors to know; and (ii) any information that may be material for investors to make an informed investment decision. The accompanying liability under the 2018 ICDR Regulations falls on the issuer and the merchant bankers; thus, from their perspective, it was wise to scrutinise each piece of information and test its materiality prior to including or discarding it.
The SEBI Order mandated that an issuer and merchant bankers ought to assess information from the lens of a reasonable investor. The SAT Order, on the other hand, emphasises the limited scope for subjective analyses of what is ‘material’, but goes on to conclude that it falls on the issuer to be “undoubtedly sure” of the information being ‘irrelevant’ to it or the issue whilst determining whether disclosure is mandated or not. Taken conversely, the SAT Order seems to have mandated that all information that is ‘relevant’ to the issuer requires disclosure without determining whether such information is material for investors to make an informed investment decision. This finding of SAT may create more confusion than clarity on what disclosure standards are mandated for issuers undertaking primary issuances of securities.
Way Forward for Issuers
Harmonising the extant disclosure regime and practice with the SAT Order may be a difficult task: on one hand, an initial public offering working group is vested with discretion to determine what is ‘material’; and, on the other, its discretion is fettered to testing whether the information is ‘relevant’ to the issuer or not. Two standards of disclosure may now be at play.
Considering the liability attached to offer documents, issuers and merchant bankers may now be wary of discarding any information from disclosure, lest it be tested in the future in a manner similar to Electrosteel. The immediate impact of this on future offer documents may be over-disclosure of information to check the ‘relevance’ tick-box set by the SAT Order. Whilst over-disclosure may be favoured by the regulator, it may not impact investors and investment decisions positively. Less sophisticated investors may be saddled with information irrelevant to an investment decision and may have to spend more time and resource to separate the grain from the chaff. The information asymmetry that offer document disclosure seeks to balance in securities markets may only grow higher if the SAT Order is followed to its word.
It remains to be seen what market participants make of the SAT Order. Whilst in form it upholds the SEBI Order to the extent of its findings, it goes beyond the SEBI Order in its reach. The SAT Order’s expanded disclosure regime may soon face an appeal in the Supreme Court.
The substitution of a ‘materiality’ standard to test whether information is suitable for disclosure with a ‘relevance’ standard runs counter to the intent behind the disclosure regime under the 2018 ICDR Regulations, and may only serve to expand the liability that issuers and merchant bankers undertake in a primary market offering. As a consequence, over-disclosure and not material disclosure may become the norm and investors may have to now locate material information in thicker offer documents prior to making their investment decisions. It may also behove SEBI to clarify the contours of the SAT Order to ensure that it does not run contrary to the streamlined disclosure standards prescribed by 2018 ICDR Regulations.
 Adjudication Order No. AK/AO- 8-12/2016, Securities and Exchange Board of India (March 31, 2016), available at https://www.sebi.gov.in/enforcement/orders/mar-2016/adjudication-order-in-the-matter-of-m-s-electrosteel-steels-limited-and-m-s-electrosteel-castings-limited-_32230.html
 Regulation 57(1) of the 2009 ICDR Regulations: “The offer document shall contain all material disclosures which are true and adequate so as to enable the applicants to take an informed investment decision” (this regulation has been retained as Regulation 24(1) of the Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2018 (the 2018 ICDR Regulations)).
 Regulation 57(2) of the 2009 ICDR Regulations: “Without prejudice to the generality of sub-regulation (1):.. the red-herring prospectus, shelf prospectus and prospectus shall contain: (i) the disclosures specified in Schedule II of the Companies Act, 1956; and (ii) the disclosures specified in Part A of Schedule VIII, subject to the provisions of Parts B and C thereof.” (this regulation has been substantially retained as Regulation 24(2)(a) of the 2018 ICDR Regulations)