On October 8, 2020, the Securities and Exchange Board of India ("SEBI") amended the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 ("LODR Regulations") vide SEBI (Listing Obligations and Disclosure Requirements) (Third Amendment) Regulations, 2020 ("Amendment"). The Amendment was brought in to require listed entities to make certain disclosures in case of initiation of forensic audits (by whatever name called), including specifically:
- The fact of initiation of forensic audit, along with the name of the entity initiating the audit and reasons for the same, if available; and
- The final forensic audit report (other than for forensic audit initiated by regulatory/enforcement agencies) on receipt by the listed entity along with comments of the management, if any1.
Notably, the Amendment places the obligation (as set out above) in Part A of Schedule III of the LODR Regulations, which lists events reportable by an issuer without application of a materiality threshold. Citing the 'information asymmetry' that results from forensic audits that are initiated by lenders or even the management of the listed entity itself, the Amendment has the objective of allowing concerned regulators and shareholders equal access to potentially negative information.
- KEY ASPECTS OF THE AMENDMENT
- Types of 'forensic audits' that must be disclosed
While the Amendment does not define the scope of 'forensic audit' covered within its purview, SEBI has, in subsequent FAQs on the matter2, clarified that only those forensic audits which are initiated "with the objective of detecting any misstatement in financial, mis-appropriation/siphoning or diversion of funds" will fall under the ambit of the Amendment. By this definition, SEBI has excluded any forensic audits that may be initiated due to other reasons such as product quality control practices, manufacturing practices, recruitment practices, or supply chain process including procurement. SEBI has further clarified that any matter that would not require any revision to the financial statements would not be included in the definition of a 'forensic audit' necessitating appropriate disclosures. SEBI has also clarified that certain information can be expunged from the final forensic audit report, such as any personally identifiable information and commercially sensitive information.
- Forensic audits initiated by the company must also be disclosed
SEBI has stated that forensic audits need not be necessarily initiated by third parties and that a disclosure requirement is triggered even if the management of the listed entity initiates a forensic audit. Since the Amendment does not seem to indicate any retrospective effect, it will apply to all audits which are initiated and audit reports which are finalized after October 8, 2020.
- INDUSLAW VIEW
While investigations by regulatory/enforcement agencies resulting in any material regulatory action are already covered under extant disclosure requirements, the Amendment plugs the gap in the unequal access to disclosures. The Amendment has nevertheless faced criticism, primarily because premature disclosures of this kind may harm the reputation of the company and create stock volatility even if the final audit report is bereft of any actual wrongdoing or fraud.
Interestingly, the second limb of the Amendment requires disclosures of the final forensic audit report along with management remarks except for reports initiated by regulatory/ enforcement agencies. From SEBI's agenda note3, it appears that this exclusion was built in since the LODR Regulations already envisage disclosure of material actions resulting from regulatory investigations. The language of the Amendment suggests that while listed companies have no wriggle-room from reporting findings of forensic reports initiated by their management/ third parties, they may refrain from disclosing the final forensic reports commissioned by enforcement agencies if they consider the findings non-material. While this point seems technical, one hopes that this is not aggressively interpreted by companies to withhold crucial findings resulting from regulatory investigations.
Irrespective of one's opinion on this issue, the Amendment will certainly encourage listed entities to increase vigilance on matters relating to fraud, corruption or any other form of financial impropriety.
1. Sub-clause 17 of Clause A, Para A, Part A of Schedule III of the LODR Regulations.
2.Frequently Asked Questions on Disclosure of Information Related to Forensic Audit of Listed Entities at https://www.sebi.gov.in/sebi_data/faqfiles/nov-2020/1606474249513.pdf
3.Agenda of SEBI's board meeting of September 29, 2020 available at https://www.sebi.gov.in/sebi_data/meetingfiles/oct-2020/1602155024437_1.pdf
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