Prefatory Remarks
Over the past decade, reforms in the business sector have accelerated not only the need for redefining business models, but also the demand for independent research proposals on corporate ecosystems that can allow investors to keep a vigil eye on the company’s activities. In such a scenario, investment advice and voting recommendations to investors have acquired the centre stage.
Institutional advisers like Foreign Portfolio Investors, Mutual Funds, Real Estate Investment Trusts, etc. rely on detailed studies provided by proxy advisers while making key voting decisions. Proxy advisers critically analyse data, voluminous documents and other information, and translate legal jargon into plain English. They are known to quench the Environmental, Social and Governance (ESG) needs of investment behemoths by offering them critical insights on various corporate plans. Barely three proxy advisers have gained a footing in the Indian proxy advisory industry, namely InGovern Research Services Private Limited, Institutional Investor Advisory Services (“IiAS”) and Stakeholders’ Empowerment Services (“SES”). Indian proxy advisory firms are regulated under the Securities and Exchange Board of India (Research Analysts) Regulations, 2014 (“the 2014 Regulations”). In order to regulate the operations of this nascent industry and prevent errors in the detailed and sensitive assessments conducted by such proxy advisers, the Securities and Exchange Board of India (“SEBI”) supplemented the extant regulatory framework with Procedural Guidelines 2020 (“Guidelines”), effective from 1 January 2021.
The Guidelines demand proxy advisers to make their detailed research blueprints public and solicit views of the issuers on the same in the name of accuracy. In this article, the author argues that the SEBI overlooked certain facets of these Guidelines which may undermine the liberty of the businesses’ voting advice and establish formidable barriers to entry for new firms. It is also contended that broadcast of confidential information (i.e. research methods and techniques) by proxy advisers would destroy their business model.
A Brief Perusal of the Guidelines
As per Regulation 2(p) of the 2014 Regulations, ‘proxy adviser means any person who provide advice, through any means, to institutional investor or shareholder of a company, in relation to exercise of their rights in the company including recommendations on public offer or voting recommendation on agenda items.’ The recommendations proposed by the proxy advisers are based on ‘significant news or events’, i.e. information available to the public that can have material impact on the financial position of the company.
Considering the influential position proxy advisers have grown to occupy in a company’s decision-making and governance process over the recent past, a regulatory framework soon became necessary. Accordingly, in August 2020, the Central Government’s most reliable financial watchdog (i.e. the SEBI) issued a slew of instructions for registered proxy advisers with the intention of encouraging glasnost and improving audit efficiency in the advisory regime. They require proxy advisers to, at the forefront, disclose any possible conflicts of interest when giving advice and delineate safeguards to mitigate the effects of such conflicts. It is also believed that such Guidelines emanate from the recommendations made by the Working Group in May 2019 (“WG Report”). The rationale of the Guidelines is to ensure independence of proxy advisers by making it possible for them to reveal both potential and actual conflicts of interest. However, while it is reasonable for proxy advisers to address conflicts of interest arising out of their engagements with issuing companies and communicate the same to the clients and issuers, the SEBI seems to have turned a blind eye to the possible threats some aspects of the Guidelines can pose to the advisers.
The Guidelines, in addition to requiring proxy advisers to disclose the raison d’être behind higher standards set for the recommendations (if suggested) to their clients,[1] make it mandatory for them to divulge the research methodologies (including related assumptions) employed in developing recommendations.[2] Such a mandatory requirement is problematic. The Guidelines are silent on what encompasses the ‘the essential ingredients of a research methodology’, which makes them convoluted for proxy advisers to interpret and comply with. According to the WG Report, the components of research methodology may include general approach, sources used, consideration of local conditions, etc. It is noteworthy that proxy advisers like IiAS and SES generate revenue through their subscription-based model. For instance, IiAS charges ₹12,390 for its research report and SES charges ₹7,080 for its detailed report. Since IiAS and SES do not offer one-to-one business consultancy, publishing methodologies including the sources of information (except non-publicly available material) can jeopardise the competitiveness of a proxy adviser, as the probability of leakage of sensitive details can be fairly high.
Another issue is with respect to how the SEBI has not distinguished the present Guidelines from Regulation 23(2)(i) of the 2014 Regulations, which make it compulsory for the proxy advisers to disclose the ‘extent of research involved in a recommendation’. The SEBI must avoid the confusion regarding this significant overlapping between the concerned Guideline and Regulation, and come out with the detailed list of relevant aspects of research methodology to be produced by the proxy advisers.
A more perplexing Guideline requires the proxy advisers to share their report with the clients and the company at the same time. In case of any difference of opinion between the company and proxy adviser, the proxy adviser may either revise the recommendation in the addendum report or issue an addendum to the report with its remarks, both of which are unnecessarily burdensome for the advisers.[3]
Though one may advocate that communicating significant information to the issuers would help in reducing information asymmetry, it would render the process futile as issuers already have enough alternate resources to publish a ‘different viewpoint’. The Working Group had also noted that inviting comments (except for factual errors) from issuers might not bridge the information gap, but rather allow issuers to influence the proxy advisers to provide recommendations in their favour. Moreover, the issuing companies can now approach the SEBI against the proxy advisers under the grievance resolution mechanism, making the concerned Guidelines meaningless. Issuers have been averse to dissenting opinions. In ITC Ltd. v. Institutional Investor Advisory Services (IiAS), ITC alleged that IiAS made defamatory statements against it by recommending investors to vote against its plan to pay a monthly remuneration of Rs. 1 Crore to its Chairperson Y.C. Deveshwar. The Hon’ble Calcutta High Court disposed of the matter, as ITC did not have a cause of action. This case is a testament to how issuers attempt to interdict the proxy advisers from supplying impartial analytical research work. Adding to their woes, the SEBI has now made it obligatory for proxy advisers to get their research reports homologated by issuers before they release them. It can be inferred that the issuing company may act in a supervisory capacity by compelling proxy advisers to accommodate its perspective and hence suppress their independent voice.
Fascinating Tale of the United States of America
India and the USA have embraced almost identical regulatory arrangement. In fact, the Guidelines mirror the Supplemental Guidance issued by the Securities and Exchange Commission (“SEC”) of the United States of America. In August 2019, the SEC issued the supplemental guidance with respect to Proxy Voting Responsibilities of Investment Advisers, to improve accuracy and transparency of proxy voting advice. The same was adopted as the amendments to the rules governing proxy solicitations in July 2020. The SEC had opined that advice offered by proxy advisers amounts to a ‘solicitation’, and hence must be regulated under the Security Exchange Act, 1934. As per the guidance, proxy advisers are now required to provide specified conflicts of interest disclosures in their proxy voting advice and share their advice with the registrants (issuers) at, or prior, to the time when such advice is disseminated to the proxy voting advice business’s clients. Challenging the validity of the guidance, Institutional Shareholder Services Inc. (“ISS”) brought a civil action against the Securities and Exchange Commission (SEC) and Walter Clayton III (Chairman of the SEC) in the Federal District Court for the District of Columbia. ISS reasonably argued that proxy advice does not constitute a ‘solicitation’ as the job of a proxy adviser is restricted to producing comprehensive reports to assist investors, and does not extend to determining the outcome of a shareholder vote. Additionally, it was contended that the disclosure of advice to the registrants would compel the proxy advisers to take into account the company’s management interests, thereby undermining the credibility of proxy advisers’ neutral work. Since the matter is sub judice, it would be interesting to hear the arguments of the SEC.
Conclusion
The author believes that making it compulsory for the proxy advisers to reveal their research methodologies, which is their unique selling proposition to clients, can prove to be patently harmful to the business and adversely affect the fiduciary relationship. After scrutinising both the Indian and American situations, it can be deduced that giving registrants (issuing companies) the opportunity to review voting advice is a fanciful move as it would endanger the effective voice of proxy advisers in corporate governance. Further, since the proxy advisers do not urge shareholders to vote as per their whims ‘to achieve a specific outcome’ in a shareholder vote and are unconcerned about how shareholders vote, making it mandatory for the proxy advisers to submit their reports to registrants would leave them to the mercy of issuing companies. Indubitably, by bringing in such arbitrary Guidelines for proxy advisers, the SEBI has turned from a monitor to an uninvited Big Brother. It will now be interesting to see if the Indian proxy advisers will follow in the footsteps of their US counterparts and ‘initiate a litigation’ against the SEBI to protect their freedom or will ‘hang back’. It is advisable that the SEBI should conduct a thorough cost-benefit analysis of its Guidelines again. A more democratic system is a desideratum which would allow proxy advisers to raise more pertinent concerns regarding the agenda items of a company and at the same time take care of issuers’ obnoxious acts such as abuse of power.
(This post has been authored by Daksh Aggarwal, a 3rd Year Law Student at Campus Law Centre, Faculty of Law, University of Delhi)
References
- SEBI Procedural Guidelines for Proxy Advisors 2020, guideline 1(f). ↑
- SEBI Procedural Guidelines for Proxy Advisors 2020, guideline 1(b). ↑
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SEBI Procedural Guidelines for Proxy Advisors 2020, guideline 1(e). ↑
Cite As: Daksh Aggarwal, ‘Beware Proxy Advisers! The Big Brother is Watching: Key Issues with SEBI’s Puzzling Guidelines for Proxy Advisers’ (The Contemporary Law Forum, 14 October 2020) <https://tclf.in/2020/10/14? beware-proxy-advisers-the-big-brother-is-watching-key-issues-with-sebis-puzzling-guidelines-for-proxy-advisers> date of access.