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Are Infosys, TCS pre-earnings disclosure standards fair?

Infosys argues that it didn’t provide a formal revenue guidance for 2014-15, but saying growth for the year will be at the lower end of the range can make a meaningful difference to quarterly growth expectations. Photo: Hemant Mishra/ MintPremium
Infosys argues that it didn’t provide a formal revenue guidance for 2014-15, but saying growth for the year will be at the lower end of the range can make a meaningful difference to quarterly growth expectations. Photo: Hemant Mishra/ Mint

The Infosys, TCS examples show that Sebi must incorporate norms for meetings where an informal guidance is provided for a quarter

Infosys Ltd’s chief executive S.D. Shibulal’s comments at an investors’ forum on 12 March were not ordinary by any standard. “Our revenues may be near the lower end of our FY14 guidance," he said, adding that lower-than-expected growth in the fiscal fourth quarter may impact the company’s growth in the next financial year. He attributed this to the slowdown faced by clients in certain industries as well as a mismatch in skills vis-à-vis what clients were looking for.

The next day, Infosys shares fell by 8.5% and its market capitalization eroded by about $3 billion. In this backdrop, it may seem naïve to ask if Infosys’s comments amounted to disclosure of material non-public information. But the company disagrees, citing that the comments fell within its already public guidance range. (Read Infosys’s full response here)

When is information material?

The US Securities and Exchange Commission’s Regulation Fair Disclosure (Reg FD) states that it relies on the following definitions established by case law to determine if information is material or not: a) there is a substantial likelihood that a reasonable shareholder would consider it important in making an investment decision and b) there is a substantial likelihood that a fact would have been viewed by the reasonable investor as having significantly altered the total mix of information made available.

Securities and Exchange Board of India (Sebi) has defined price-sensitive information as “any information which relates directly or indirectly to a company and which if published is likely to materially affect the price of securities of company".

The 8.5% drop in Infosys’s share price, on the back of unusually high volumes, shows that a number of shareholders found the information material enough to alter their investment decisions. An Infosys spokesperson says, “We believe no reasonable assessment would have indicated that a disclosure which said that we would be at the lower end of a narrow guidance range of 11.5% to 12% would move the market and in any way, nor do we speculate on market movements."

Infosys also argues that it didn’t provide a formal revenue guidance for 2014-15. But saying growth for the year will be at the lower end of the range can make a meaningful difference to quarterly growth expectations. In this case, the lower end of the range results in growth of around 8% in the March quarter, compared with 10% at the higher end of the range. Not only is this materially lower than previous quarters, it also, to use Shibulal’s words, acts as a base and hence has a bearing on growth in 2014-15.

According to analysts at two institutional brokerages, Infosys’s comments effectively amounted to a profit warning, and that while the disclosure standard followed by the company may be within legal boundaries, it wasn’t fair.

For one, even though the company’s website provided a live webcast to the event, there was no way for anyone to know that the company was going to make comments related to its earnings in the forum. Just two weeks earlier, Infosys had webcast another investor event, but hadn’t said anything material. Infosys says it is not only fully committed to Reg FD standards, but was also upholding highest levels of transparency by explaining the challenges it was facing in the marketplace in an open investor forum.

Why is it important to make this distinction between material and non-material information? If the information is acknowledged as material, then fair disclosure demands the company sends a notice, ideally to the stock exchanges on which it is listed, drawing the public’s attention to the company’s proposed announcement. Infosys says there was adequate public notice as it was the lead story on the investor relations section of its website, and that multiple people accessed the event. Of course, given the company’s view that the information wasn’t material, one could argue that it needn’t have bothered about the public notice.

But if one comes to the view that the information was material, it means that insiders should be barred from trading ahead of such release of price sensitive information.

Insider trading concerns

In early 2013, Infosys had come under similar scrutiny for pre-earnings comments made to analysts. Back then, a finance executive at a large Indian technology firm had said Infosys’s comments could not be termed as wrongdoing unless some senior company officials sold large chunks of shares. As luck would have it, one of Infosys’s senior employees sold shares just a few hours before the profit warning in March this year.

Whether or not Infosys views the information it shared as material and non-public, regulators must wake up to the possibility of abuse by insiders. While this is not to suggest that the Infosys employee is at fault (a fair investigation will have to be done by regulators before such an assertion can be made), it does serve as an example of possible misuse by insiders ahead of earnings pre-announcements.

TCS: selective disclosure?

A few days after Infosys’s conference, Tata Consultancy Services Ltd (TCS) met analysts from most brokerages to give a customary pre-earnings update. TCS also denies it shared any new, non-public information, saying that it merely reaffirmed its extant business outlook and that the information it shared was either already a matter of public record or was an inference based on information in the public domain. (Read TCS’s full response here)

But nearly all analysts who attended the meet wrote in notes to clients that the company had indicated that growth in the March quarter will likely be lower compared to the December quarter. Based on this input, each of these analysts revised their growth target for the March quarter to a precise 2%. TCS’s market capitalization fell by about $2.7 billion the next day.

The company’s closed-door meeting even qualifies for violations of selective disclosure under Reg FD, if one takes the view that the information was material; although, of course, the company’s shares are not listed in the US. Sebi rules don’t throw much light on pre-earnings announcements by companies.

But these recent examples show that Sebi must incorporate norms for pre-announcements or meetings where an informal guidance is provided for a quarter. Barring such disclosures doesn’t make sense as it works against transparency and worsens information asymmetry vis-à-vis insiders. Instead, companies must be required to make all such disclosures public, starting with a public announcement of the date on which it plans to make the pre-announcement or informal guidance.

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