Stricter regulations for large unlisted firms? Bad idea

As per the report, the government is mulling imposing stricter disclosure norms on ‘large’ (although the parameters for classifying an unlisted entity as large have not been decided upon yet) unlisted firms, including financial and regulatory compliance reporting on a quarterly basis. It is only going to add to the compliance burden of such entities and can hardly be considered as improving the ease of doing business.

Of the more than 22 lakh companies registered with the Ministry of Corporate Affairs, only a tiny fraction -- around 5,300 -- are publicly listed. The rest are unlisted for the simple reason that the scale, scope and nature of their business do not warrant raining equity capital from the markets, which would bring in the need for listing – and the attendant regulatory and reporting requirements.

According to the report, the government is concerned with recent incidents of governance failures at some large unlisted entities, including start-up unicorns which are valued in billions of dollars, and have a large scale of operations, but continue to be closely held and are not listed. Since unlisted entities come under a lighter regulatory framework, the fear is that serious issues at such entities, which may have systemic repercussions, will not come to notice till it is too late.

That is not an unjustified concern. However, it is not as if the authorities are short of provisions under existing acts and rules to keep a close eye on systemically important, large unlisted firms. In fact, after the collapse of IL&FS, the corporate affairs ministry issued a notification as far back as January 2021 mooting quarterly and half-yearly financial reporting for specified large, unlisted companies.

In the case of conglomerates, where the holding company or companies may be unlisted but the subsidiaries are listed, markets regulator SEBI already has provisions to ensure a higher level of disclosures by such entities, as they can introduce “systemic risk" through related party transactions. Even listed debt instruments issued by unlisted firms come under SEBI’s purview.

It is moot whether mere disclosure of financial performance at more frequent intervals is sufficient to ensure higher standards of corporate governance in companies. In fact, all the major scams of recent years have occurred in large, listed entities, which had, on paper, been complying with all the regulations. From Satyam Computer to Gitanjali Gems, from IL&FS to ICICI Bank, severe failure of corporate governance and oversight became public well after the event. All these firms were compliant with all regulations, had well-qualified independent directors on their boards and had even won awards for corporate governance, but had nevertheless managed to hoodwink shareholders, regulators and banks alike.

However, regulatory response should not be based on the misdeeds of the few but requirements of the many. The reason that many start-ups – even those which have reached a large scale of operations – prefer to stay unlisted is that it provides them with the flexibility to make quick decisions in a rapidly changing environment. Also, since they are closely held, they have a limited number of shareholders to answer to. One could argue that it is up to these investors to ensure the safety of their investments.

Introducing additional layers of financial disclosures will add to the compliance burden of legitimate start-ups and businesses, while doing little to prevent acts of fraud, for which, in any case, many provisions exist in civil and criminal statutes. It is also arguable whether the authorities have the bandwidth to deal with a flood of financial statements and take preventive action in time. On the other hand, disclosure of their financials may render them at a competitive disadvantage.

If there was a pressing need for changing the disclosure requirements of unlisted companies – large or otherwise – it is probable that the Company Law Committee, consisting of eminent experts, would have suggested it in their report, which was submitted last year. That they didn’t should indicate to the government on the course of action it should adopt in the matter – leave well enough alone.