Towards Transparent Markets: Decoding SEBI’s consultation paper on Market Rumours

Introduction

SEBI’s recent consultation paper seeks to enhance market integrity by introducing a new framework for addressing market rumours. In response to concerns about market manipulation through rumours, SEBI implemented Regulation 30(11), demanding that listed companies actively address rumours reported in mainstream media. To ease the burden and ensure effective implementation, SEBI is taking a phased approach, starting with the top 100 companies in February 2024 and expanding to the top 250 by August. Recognizing the need for industry expertise, SEBI collaborated with three major associations – ASSOCHAM, CII, and FICCI – to form the Industry Standards Forum (ISF). This forum is tasked with developing clear and practical standards for rumour verification, aiming to strike a balance between upholding market integrity and minimizing unnecessary compliance burdens on companies.

This post aims to analyze the proposed changes, highlighting their potential benefits and challenges, and suggest recommendations for striking the right balance between regulation and market efficiency.

Proposed Framework

Shifting Focus from “Material Events” to “Material Price Movements”

The current regulations require listed entities to verify rumours only if they pertain to “material events,” meaning specific occurrences with the potential to significantly impact stock prices. However, a new proposal suggests focusing on “material price movements” instead. This proposed shift signifies a potential move towards a more market-driven approach to rumour verification, prioritizing actual price impact over the nature of the underlying event. This means rumours would trigger verification not based on the underlying event but on whether they cause a substantial swing in the stock price itself.

This proposed change is motivated by a desire to capture impactful rumours that may lack a clearly defined “material event”. For instance, rumours about potential mergers or acquisitions, even unconfirmed, can cause significant price fluctuations despite not being tied to a specific announcement. The current system might miss such potentially manipulative rumours because they lack the formal event trigger.

To determine material price movement, the framework employs a two-pronged approach. Firstly, it takes into account the price range of the securities, applying lower percentage variation thresholds for high-priced stocks and vice versa. This ensures context sensitivity, preventing unnecessary verification for minor fluctuations in high-value companies. Secondly, it indexes price variations to benchmark indices (Nifty50/Sensex), further factoring in broader market dynamics and preventing false triggers during general market swings. This aims to ensure the materiality threshold adapts to different stock types and broader market conditions. For instance, a smaller percentage change would trigger verification for high-priced stocks, while low-priced stocks might require a larger swing. Factoring in benchmark index movement helps isolate the rumour’s specific impact, avoiding false positives triggered by general market shifts.

The proposed verification timeline would be linked to the price swing, requiring prompt clarification within 24 hours of the movement instead of a fixed timeframe after media reporting.

Calculating the ‘Unaffected Price’: SEBI’s Proposed Frameworks

Another critical issue in the realm of market rumours and their impact on stock prices is determining the “unaffected price” when a listed entity confirms such rumours, causing significant price movements. This concept holds weight since rumours can artificially inflate or deflate prices, distorting fair valuation for transactions like preferential issues, buybacks, and M&A deals.

SEBI’s consultation paper proposes two frameworks to address this:

Framework A:

This approach uses the date before rumour confirmation as the “relevant date” for pricing, essentially rewinding the clock to a period presumably unaffected by the rumour. While attractive for its simplicity, it potentially disadvantages shareholders by neglecting subsequent positive announcements or market developments that could benefit the stock price. Additionally, it opens the door for manipulative rumour-mongering, where entities intentionally push rumours to secure favourable pricing later.

Framework B:

This framework aims for a more nuanced approach. It excludes only the price variation directly attributable to the rumour and its confirmation from the calculation of the look-back period for determining average pricing. This ensures shareholders benefit from genuine market developments while still safeguarding against rumour-driven distortions. However, challenges remain in accurately isolating the rumour’s impact, especially with volatile markets and potential multi-stage rumour confirmations.

Obligation on Promoters, Directors, & Key Managerial Personnel (KMPs)

The SEBI’s proposal to mandate P&DK’s swift response to market rumour queries presents a fascinating legal and economic dilemma. While Regulation 30(11) of LODR Regulations already imposes a disclosure obligation on listed entities, concerns remain regarding its effectiveness when rumours implicate P&DK themselves. Proponents argue that a mandatory response incentivizes transparency, deters manipulation, and protects investors. However, this legal obligation must be carefully balanced against potential burdens and unintended consequences. Forcing P&DK to disclose sensitive information under pressure could raise privacy concerns, stifle innovation, and potentially exacerbate market volatility. Additionally, determining the scope of “relevant” rumours and ensuring fair and timely responses necessitates clear guidelines and robust enforcement mechanisms. Ultimately, the effectiveness of this proposal hinges on striking a delicate balance between enhancing transparency and protecting P&DK from undue burdens. Careful consideration of alternative solutions, such as independent rumour verification or targeted disclosure requirements, will be crucial in crafting a framework that fosters investor confidence without compromising individual rights or market efficiency.

Concerns

Calibrating Materiality: Considering Price Range and Market Indices

While the framework promises increased efficiency and market-centricity, challenges remain. Attributing price movements solely to rumours in dynamic market situations can be tricky and prone to misattribution. It assumes a direct link between price fluctuations and rumour, which could be difficult to prove in complex market scenarios where multiple factors influence price fluctuations.

Furthermore, determining “material” movement through a combination of price range and benchmark indices introduces complexity. Ambiguous criteria could lead to inconsistent application and potential manipulation, where companies might artificially trigger verification requirements to influence market sentiment. Defining thresholds consistently across diverse securities and market conditions will be crucial to avoid triggering unnecessary verifications for smaller companies or during broader market corrections.

The proposed 24-hour verification timeline, though aiming to mitigate volatility, might create an undue burden on companies. Constant monitoring of price movements and conducting efficient verifications within this tight timeframe could prove resource-intensive for some entities.

Framework A vs. Framework B: A Comparative Analysis

Framework A: Simplicity with Potential Risks

Framework A adopts a straightforward approach, using the date before rumour confirmation as the “relevant date” for pricing transactions. While this aligns with existing regulations, it raises concerns about potential downsides:

Ignoring Subsequent Events: Price changes triggered by announcements or developments after rumour confirmation are disregarded, potentially depriving shareholders of fair value.

Manipulation Window: The framework provides a window for insider manipulation, where entities could spread rumours, confirm them, and then take advantage of the unaffected price to acquire shares at a discount.

Framework B: Targeted Approach with Implementation Hurdles

Framework B aims to isolate the impact of rumours on price by excluding rumour-induced fluctuations from the VWAP calculation. This targeted approach offers potential advantages:

Fair Value Protection: Shareholders are protected from being priced out based on rumor-inflated or deflated prices.

Transparency and Certainty: The framework promotes transparency by clarifying the pricing basis and potentially reducing litigation disputes.

However, implementing Framework B presents challenges:

Determining Rumor Impact: Accurately isolating the price movement attributable solely to the rumour within the broader market noise can be complex, requiring sophisticated analysis and potential subjectivity.

Timeframe Uncertainty: The chosen timeframe of one trading day for identifying rumour-related price changes might not always capture the full impact, particularly in volatile markets or slower-developing news situations.

Recommendations

Choosing the optimal framework: SEBI’s proposed frameworks for unaffected prices after market rumours present a trade-off between simplicity and fairness. Framework A, aligning with existing regulations, is easy to implement but risks ignoring post-rumour developments and facilitating manipulation. Framework B, though complex and requiring clear guidelines, offers targeted protection against unfair pricing and fosters market transparency. While Framework A might be suitable for simpler transactions, Framework B’s emphasis on fairness and accuracy makes it the better overall choice, providing robust regulatory support and clear disclosure address implementation challenges. Ultimately, choosing the optimal framework requires weighing fairness against practicality, with careful consideration of market volatility and regulatory capacity. Protecting shareholders from unfair pricing should be the paramount objective, and while Framework B holds promise, achieving its full potential necessitates the following changes:

Use pre-rumour confirmation date as the “relevant date” for pricing, but adjust the VWAP to exclude price variations attributable to the rumour and its confirmation within a defined timeframe (e.g., 3-5 trading days) based on a clear methodology.

Tiered unaffected price application: The chosen timeframe for unaffected price (60 or 180 days) should be flexible and sensitive to market volatility and based on the transaction complexity with simpler cases using a pre-defined timeframe and more complex ones utilizing detailed analysis.

Exploring Additional Triggers: The framework’s reliance on stock price movements risks neglecting potentially impactful non-price-related rumours. Exploring additional triggers, such as social media trends or significant media coverage, could provide a more comprehensive view of market sentiment and potential manipulation.

Transparency and Disclosure: Clear guidelines and mandatory disclosures regarding rumour confirmation, price calculations, and rationale for the chosen framework are crucial to building trust and preventing manipulation.

Market Noise Filter: Employ data analytics tools and filters to differentiate rumour-induced changes from natural market movements, further minimizing subjectivity and manipulation potential.

Phased implementation: Pilot Framework B with a limited set of companies and transactions, allowing for adjustments based on real-world testing and refinement before wider adoption. This minimizes market disruption and ensures optimal effectiveness.

By implementing these changes, Framework B can become a truly “ideal” framework, safeguarding investors from unfair pricing while ensuring market efficiency and transparency.

Conclusion

Therefore, while the framework’s focus on market impact is commendable, careful evaluation of its feasibility and potential downsides, including issues of clarity, complexity, and burden on companies, is essential before widespread implementation. Ultimately, the goal should be to ensure prompt and accurate responses to market-impacting rumours while minimizing unnecessary burdens and safeguarding against manipulation. Further discussion on potential alternative models, such as tiered verification based on severity or rumour type, could lead to a more balanced and effective solution. The success of ISF’s efforts will ultimately depend on its ability to address these concerns and establish a system that fosters both transparency and ease of doing business. Therefore, while the framework holds promise in its market-centric approach, further refinement is needed to address concerns regarding ambiguity, complexity, and potential burdens on companies. Open discussions and collaborative efforts involving all stakeholders can help optimize the framework, ensuring its effectiveness while minimizing unintended consequences.