A good start on regulating proxy advisory firms, but more needs to be done

Indian companies as a rule face very little heat from activist shareholders with their all-powerful promoters, compliant boards and passive institutional investors. Proxy advisory firms — which offer independent recommendations to shareholders on voting decisions, analyse corporate actions and publicly comment on corporate governance issues — thus perform a useful role in raising investor awareness. But instances of proxy advisors providing diametrically opposing views on the same governance issue, cherry-picking companies for subjective critiques and making recommendations on companies despite clear conflicts of interest, have flagged the need for these firms to be held to higher standards of regulation and governance. A deeper dive into their operations has also revealed the possibility of proxy firms sharing stakeholders or board members with, and earning advisory fees from, companies on which they provide ‘independent’ research recommendations. This is why it is good to see SEBI move from a mere Code of Conduct for proxy advisory firms to framing specific operational regulations for them, despite these firms being subject to minimal regulations globally.

The new guidelines, drawn mainly from recommendations of a working group report, lay down certain basic SOPs for proxy firms. To prevent them from sharing their reports with companies pre-release and to ensure balance, proxy firms will now be required to release their voting recommendations and research to the company and their clients at the same time, while allowing the company an opportunity to refute or clarify on the issues they flag. If there is a rebuttal, they are expected to issue addendums to their reports. Where proxy firms hold companies to a higher standard of governance than mandated by the legal framework, they are required to expressly justify this. Most importantly, every report from a proxy advisory firm will now be expected to carry explicit disclosures on conflict of interests, if any, with the companies they are covering, with details of the measures they’ve taken to mitigate this conflict. This welcome rule seems to have sprung from recent instances of proxy firms taking a pro-management view of voting decisions in companies with which they share key board members or stakeholders.

While these guidelines make for a good start, SEBI can consider further steps to make the operations of proxy advisors more transparent to investors. Requiring these firms to disclose the identity of their owners, board members and key personnel on their websites can help investors discern conflict of interest issues for themselves. Mandating disclosures of their revenue models, key income streams and large clients can also help. Given that analysing corporate actions and governance issues requires a firm grasp of legal matters and is a very different kettle of fish from researching companies or stocks for buy or sell recommendations, SEBI must also consider mandating a distinct set of eligibility criteria and qualifications for the owners and employees of proxy advisory firms instead of trying to force-fit these firms under its Research Analyst regulations.